Innovation, that fundamental characteristic of survival, could be the key driver of fund-picking success this year, and many in the industry have already embedded this key strand into their forward-looking strategies.
‘There are several ways to be successful in asset management: you can either try to invest in the right pick every year or you can be innovative by introducing clients to new sources of value,’ says Nicolas Moussavi.
‘We are looking at retaining the former and improving the latter. It doesn’t have to be a big shift in our investment thinking, as we want innovation to be part of our DNA, but our choices are always driven by what clients want.’
Moussavi, who is head of mutual fund selection at Lyxor Asset Management, believes innovation needs to be more than a simple buzzword attached to traditional funds in the manner of added bells and whistles, such as different fee structures or time horizons. Rather, selectors need to venture into entirely new territories and do something truly different.
‘We focused on a few innovative ideas and launches last year,’ says the Paris-based investor. ‘For instance, we added a strategy covering the relatively niche area of floating rate note high yield to our approved fund list.
‘The asset class has three main advantages: it benefits from a floating rate benchmark; provides investors with a good hedge against rising rates; and has a high coupon over this floating benchmark providing a good carry and Ucits compliance, contrary to loan funds.’
Moussavi, who has been a strong advocate of Alternative Ucits funds, has also responded to client demand for more rarefied areas of the market through strategies offered in-house.
‘In the near future we are looking to launch an Alternative Ucits fund which will target subordinated financial debt, but the way we innovate here is to ensure it will not expose investors to too much beta.
‘This means the managed account will tap into the long side on legacy, insurance and new generation financial credit, such as CoCos, while also benefiting from a long/ short overlay. In addition it offers the fund manager greater flexibility.’
Politics have helped guide new investment ideas for José María Martínez-Sanjuán (pictured), who believes US President Donald Trump’s business-friendly attitude will translate into greater corporate action. Santander Asset Management’s head of manager research & selection is therefore moving quickly to put event-driven funds on his buy-list.
‘In 2016 we made a clear call on event-driven,’ he says. ‘While the Obama administration maintained a quite aggressive policy of antitrust enforcement, Trump is likely to pursue a much more merger-friendly policy.
‘US M&A activity volumes remain robust despite coming from record highs. Announced deal value in 2016 was $867 billion compared with 2015’s record level of $1.326 trillion, which is the fifth highest annual level since 1998.’
To play this theme Martínez-Sanjuán added the Lyxor/Tiedemann Arbitrage fund, which has been managed by Drew Figdor since 1993 and was made into a Ucits-compliant vehicle in 2013. Elsewhere, the selector made a significant move into the senior loans market, adding the Babson Capital Global Loan fund.
‘This asset class has the potential to provide competitive income and portfolio diversification, as well as a hedge against rising rates. The floating rates structure of senior loans is expressed as a nominal spread over the base rate, usually the risk-free rate, so the higher the rates go, the better for the investor.
‘It is not a new asset class and has been around for decades in the US, but the fact that it is not eligible under Ucits rules makes it hard to invest in for some portfolios,’ he says.
Finding an edge in ESG
Ian Crispo (pictured), head of liquid funds research at Deutsche Bank, is also stepping up to client demands. For the London-based asset allocator, who oversees around €15 billion, this has meant putting a greater emphasis on ESG over the course of 2016.
‘With the younger generations of wealth clients increasingly caring not only about financial returns but wider ethical issues, we have looked at impact investing.
‘We started working with a manager focused on microfinance and with another one active in green bonds. Clients want to make a difference but without forfeiting financial returns, and these areas can facilitate that,’ he says.
When it comes to investment in microfinance, Crispo says fund selectors need to have a confident grasp of the concept.
‘It requires finding a manager who has a large enough team, experienced people and a strong presence on the ground across EM countries with local offices. It also demands very robust infrastructure and loan origination and lending processes,’ he says.
‘But not just that, you also need a strong asset base to finance all this, with a diversified loan book across geographies and counterparties. In addition a good track record is key, demonstrating solid returns and an ability to avoid problem countries, and if problems occur, of successfully being able to manage them. So the bottom line is you need an institutional-type shop.’
While Crispo could not reveal a specific fund manager who had fitted the bill, he says this new approach encapsulates the changing landscape selectors are facing.
‘With elevated equity markets, rising rates, and significant macro events, there is an ever-greater need for flexible, unconstrained strategies and more differentiated alternative sources of return and income.’
For some, such as Inés Oliveira (pictured) of Portuguese group Millennium BCP, uncovering new ideas can be as much about refining selection as it is about reinvention.
‘If we look at 2016, well it puzzled us,’ she tells Citywire Selector from Millennium BCP’s Lisbon headquarters. ‘Volatility was certainly expected due to the political uncertainty across the UK, the US and Italy, but inter-asset correlations were far stronger than anticipated.
‘In this environment of unknown correlation risk, we based our selection of new strategies in 2016 on the premise that statistical correlation is countered by liquidity correlation, theoretical correlation and QE correlation.’
For Oliveira, this meant being tactical – in terms of adding dedicated managers covering miners and energy – but also sticking to a long-held view that alternative managers can defy these correlations without adding unnecessary risk to client portfolios.
‘Alternative asset classes have always been part of our portfolios but we are quite conservative in the way we invest. We usually avoid popular or, what people may call, ‘exotic’ investment ideas until they mature. So we continue to prefer Alternative Ucits vehicles as they are more transparent and liquid,’ she says.
Sharing Oliveira’s support for Alt Ucits approaches is Manuela Thies, head of multi-asset management at Allianz Global Investors. The Frankfurt-based investor says, while it is hard for a market which has been around for several years to still be deemed ‘new’, the association between liquid alternative funds and progressive investment thinking is clear.
‘When we talk about innovative funds in the current environment, liquid alternative strategies are a hot topic for us. We still find new and appealing ideas within the steadily growing universe of funds here,’ she says.
‘Take alternative multi-asset risk premia funds, for example. These can deliver high Sharpe Ratios, coupled with attractive returns and a low correlation with traditional asset classes.
‘Therefore, these investments provide an attractive diversification effect and also increase return expectations in our multi-asset portfolios. However, strategy and manager selection is crucial in order to harvest these premia efficiently and successfully, especially in times of market turbulence.’
Thies has witnessed developments within long-only offerings, she says, which move beyond short-sighted trend-following to longer-term disruptive investment. ‘So, on the equity side, we favoured themes which are driven by innovation like robotics or biotechnology over the course of last year.
‘Robotics funds, for instance, consider firms involved in the megatrends of digitalisation, automatisation and artificial intelligence – all of which will significantly change both our private lives and the manufacturing industry.
‘Access to this theme through funds was limited a while ago, but the offering has been growing steadily since last year. We are convinced that the right timing of these investments is essential, as these growth themes generally come along with a relatively high market beta.’
While new ideas are emerging, Thies says it is important not to lose sight of the fact you are attempting to build a complementary approach, not just a one-hit wonder which sits on top of your normal allocations.
‘For us there is no such thing as the “most innovative investment idea”, as we are always looking for investment opportunities in all asset classes, both in core and satellite markets.’
Thies also says fund selectors are increasingly turning to derivatives and overlays where factors such as duration risk could give them an edge. ‘Hedging and eliminating risk and carving out intended risk and alpha potential is a crucial part of our strategy, which allows us to be even more flexible and specific.
‘While investments like inflation-linked bonds may be tactical, using different instruments in combination with target funds provides a flexible, long-term strategy to achieve attractive returns for our clients.’
New power players
For many investors the term ‘innovation’ conjures up the green energy sector, which not only ticks the ESG box but also offers access to a growing market with only fledgling analyst coverage.
Multi-manager Trevor Garvin (pictured), of South African firm Nedgroup Investments, is playing this trend by combining UK-listed investment trusts focused solely on green/ alternative energy with more traditional allocations.
Having shunned equities over the course of 2015 and into 2016, Garvin says he isn’t simply tapping a sub-sector to fill a stock quota for clients, but unlocking a new way to meet demands for regular returns.
‘Take Greencoat UK Wind (UKW), which is a UK-domiciled investment trust investing in UK-based wind farms.’ he says.
‘It benefits from 19 sites and several hundred turbines that generate a total of 420 MW. UKW was the first UK-listed fund investing exclusively in wind farms. As such, it is widely regarded as the blue chip of what is a relatively small but growing sector.
‘The fund has carved out a niche within the industry by buying proven operating wind farms from the utility and contracting groups which develop them, that now need capital for their next projects. Therefore, it can provide a relatively high and reliable dividend stream that can grow at least in line with inflation,’ he says.
Garvin has also allocated capital to the John Laing Environmental Asset Group for similar reasons, such as long-term environmental benefits and regular income. He is also looking at the broader infrastructure market through private debt opportunities such as 3i Infrastructure and the SQN Asset Finance Income fund.
‘We are uncovering new opportunities which have a high level of reliable income – around 7.2% in the case of SQN – and low risk, as there is little chance of any permanent or material loss of capital. Cash flows are supported by long-term contracts and we are already witnessing healthy returns.’
Garvin’s recently-acquired assets are literally building towards a better future and it is clear that selectors too are thinking ahead to ensure their clients benefit from the dynamic trends that are reshaping investment opportunities. Be it infrastructure, Alt Ucits, green bonds or the rise of robotics, a new age of innovative idea generation is already here.
This article originally featured in the February edition of Citywire Selector magazine.