What conclusions do you draw from the crisis that has hit asset management and quantitative management in particular?
From an investor’s standpoint, the recent crisis reminds us some absolute truths that shall be useful in the future.
The first of them is that without liquidity, we are no longer in the realm of market finance. However, if the sufficient conditions for liquidity creation are hard to identify, other necessary conditions are well known with a fair access to reliable information being on top of the list. For this standpoint, the crisis is stark reminder to investors that assets listed on organized exchanges and those dealt on OTC markets differ substantially. It incites us to be realists when it comes to investing on markets where we are potentially less informed than on others. Emerging markets are an example of these types of markets.
The second truth is that it is totally irrational to believe (even if it is very tempting) that regular gains can be made without the latter paying some degree of risk even if the risk itself can be hard to identify. The most striking example from my point of view would be a product which an asset manager uses to provide protection to an individual against the risk of fire. The manager is paid a regular premium on this product. From an external point of view, the manager would be viewed as a genius…until a fire declares itself and leads to a temporary underperformance and even an immediate bankruptcy. But, consciously or not, many portfolio strategies synthesize this type of premium: credit purchasing strategies, short positions on volatility, strategies consisting in “downside averaging” etc.
Absolute return is the philosopher’s stone when it comes to investment because it feeds itself on a paradox: all investors wish to make their money “work” and obtain a regular outperformance but without taking too much risk!
Nicolas Gaussel
Finally, the third truth, which is more specifically aimed at quantitative management, reminds us that in order for a model to be used as a tool for making decisions in real situations, we must ensure that it fulfils valid conditions and this usually proves to be difficult! It would seem to me that it is essential that from the moment that an asset management style uses models, governance must be applied in order for this work to be properly carried out. For example, how is a futures price formed when interbank financing conditions are stalled? Can we use the same volatility estimators on both mature and emerging markets?
What are therefore the preferred fields of application within quantitative asset management?
According to me, whenever this question is being considered, two traps must be avoided.
The first one is the frequent positivist temptation to apply a purely quantitative analysis to all fields. I’m thinking in particular to some shortfalls in “data mining” or some optional analogies I fields where no market exists.
On the other hand, some subjects cannot escape from a quantitative treatment and not recognizing this is considered as a mistake. But in asset management, these subjects are legion. To my knowledge, an asset management style which does not include any ‘Quant’ element does not exist!
Recognizing common explanatory factors on part of the variations and co-variations among assets constitutes a first element. Therefore, equity investing which is based solely on individual financial analysis and which does not take into account the large panel of academic research on the subject looks risky from my point of view.
The use of complex products cannot, as well, exclude quantification. Without the latter, an asset manager buying sophisticated derivative products runs the risk of being surprised by the evolution of their market value over the course of their lives. Besides, he may pay a significantly higher price for the product in question.
Portfolio strategies aiming for regular profits are also recommended to make use of quantitative analysis. For portfolio volatility to drop, exposure to diversified sources of risk is necessary. This implies being able to monitor a significant number of markets simultaneously and therefore collect and analyze a huge amount of data constantly. Such a task can only be performed with quantitative tools.
Finally, quantitative tools can be very useful to further explain some judgement or observations. In the field of asset multimanagement, it can be interesting to calculate the historical probability that a 5 star fund retains its status in two years…
With this new market cycle starting, what the strategic axes that Lyxor wishes to develop?
We have adopted a strategy based on developing an excellent servicing to our clients within some strongly identified sectors: Index and ETF management, alternative management and quantitative management. Lyxor currently ranks as number 2 in Europe and number 4 in the world on ETFs. It currently has the biggest public managed account platform with the development of the first two pillars being already at a significant stage. In 2009, by building on the well established historical quantitative culture of SG, Lyxor has made the strategic choice of accentuating its development in quantitative management. In order to achieve this, we have identified three major challenges that investors will have to face during the coming years and on which we wish to help them. These are volatility management, asset allocation and absolute return products.
The recent crises have shown the propensity of the markets to accelerate or decelerate brutally which subsequently generates very random volatile periods. The course of action to take in order to gain protection or benefit from such periods is usually difficult since the use of optional products becomes necessary. On the other hand, institutional governing structures are not always fit to face such sudden market accelerations. By developing a range of products that deals with those issues, whether they are mutual funds or tailored asset management mandates, on equity, foreign exchange or bond markets, we believe that we can help investors address those new problems. Il is a real challenge since volatility strategies have a significant mortality rate. We have decided to face this challenge by developing the most robust and transparent offer possible.
Nicolas Gaussel
Asset allocation is second field within which we are looking to develop ourselves. The strong development of index management as well as that of ETFs provides investors with the possibility of investing more easily on several markets by taking into account a specific benchmark. Investors require from diversified asset managers that they differentiate themselves by making full use of the margins for manoeuvre at their disposal in order to generate above average performance. A very popular answer to this request for flexibility in allocation is what can be qualified as conviction management. While it can initially have a seductive appeal, this type of management usually implies following the judgement of a single person. Does that mean that just because the manager in question has demonstrated “flair” several times in the past this provides him with exceptional analytical abilities? At Lyxor, we prefer to face the flexibility challenge by applying the asymmetry demonstrated by investors. This would mean being more present in the market when the latter rises and less when it falls without cancelling the above average returns when the market hesitates
Finally, the last axis is absolute performance management. Absolute return is the philosopher’s stone of investment because it feeds itself on a paradox: Every investor wishes to put their money at work and generate regular above average returns without taking too much risk. However, even if a specific strategy manages to achieve this goal, it would quickly disappear since the market equilibriums would cancel it. Then again, the approach that we propose to follow is based on transparency and solidity through the application of tested principles such as diversification or the academic research on optimal portfolio management. The group has been managing programmes of this type for more than 15 years and they work very well. We are not starting from scratch and we are looking to accentuate our efforts on this market segment.
With regard to this development strategy, how do you make sure that the launch of a fund will meet the demands of the investor?
That’s a difficult question! The only thing which I can say is that as we have just discussed, each element of our offer is designed to meet an identified investment need.
How is Lyxor positioned compared to its competitors?
On the segments on which Lyxor is positioned, it is looking to deliver an offer which is clear, valuable and predictable in order to become leader in Europe or even worldwide. We do not guarantee what cannot be guaranteed which is unconditional performance. However, this does mean that we do not try to achieve it. We do so by respecting the mandate given to us by our clients and by being inspired by the three key values of Lyxor which are: innovation, flexibility and transparency.
