The nuts and bolts of a multi-asset strategy

investment viewpoints

The nuts and bolts of a multi-asset strategy

Alain Forclaz - Client Portfolio Manager

Alain Forclaz

Client Portfolio Manager

In this Q&A, client portfolio manager Alain Forclaz outlines the essentials of LOIM’s multi-asset strategy. This discussion covers how we optimise the allocation, why we prioritise liquid instruments, what our drawdown control entails and ways we cater to different risk/return appetites.

 

What is the aim of the multi-asset strategy?

Our main goal is to provide stable returns across cycles using liquid investments. Seeking stability means limiting losses, so we put capital protection1 at the fore and carefully attempt to constrain potential falls. In order to do this, we actively seek to add diversification in our portfolio through various means – beginning with a diversified investment universe, avoiding concentration when we allocate to the different assets, adding other sources of return, and actively making use of cash. We believe cash is the ultimate decorrelated asset in times of stress and is essential to active control of drawdowns.

 

How is your multi-asset strategy tailored to varying risk/return appetites? 

Ultimately, our approach aims to deliver high risk-adjusted returns, as measured by a Sharpe ratio of between 0.7-1.0. This is key because it adds to the versatility of the strategy. Applying the same philosophy, we can offer a range of risk and return profiles in our All Roads offering: our target return ranges from cash+2% to cash+8%, with our main fund lying in the middle at cash+3-5%2. In all cases, we operate within a clearly stated risk budget, which we express in terms of maximum drawdown over rolling 12 month periods. For our three profiles, the maximum drawdowns are 5%, 10% and 17.5%.

The profiles aim to cater to a broad range of investor preferences and objectives, recognizing that one size does not necessarily fit all. This flexibility enables the fund range to function transversally as either a fixed income replacement, an equity substitute, or an all-in core allocation. In this last role, the strategy is used within Lombard Odier’s own pension scheme, where it represents 25% of the total portfolio. 

 

Why operate in a liquid investment universe?

We believe liquidity is crucial to actively manage drawdowns. All Roads is an investment with a short-to-medium term horizon (1-3 years typically), which is where we believe a core allocation should sit. We believe that investors with a longer-term investment horizon should take advantage of the opportunities offered by illiquid asset classes, but these do not belong in a core allocation.

A multi-asset approach has the entire investment universe to choose from - we invest in equities, sovereign debt, credit and commodities, mostly through liquid derivatives (futures, swaps) which have now become some of the most liquid instruments in financial markets.

 

How do you address the risks of different economic cycles? How do you add sources of return?

Indeed, change in the economic environment is one of the only certainties in investing. Such change invariably creates unpredictability and could compromise our investment goal of steady performance. Therefore, we carefully balance exposure to better withstand various economic cycles. That means our strategic asset allocation takes into account how assets might react to scenarios such as: an economic expansion, contraction and inflation shocks. Then the allocation seeks to diversify the impact of any one scenario on the portfolio.

In these economic situations, it’s welcome to note that risk premia tend to react fairly predictably. For instance, in an economic expansion, equities offer the most remunerative premia. In a contraction, credit and duration are the most sensitive variables. And in an inflationary environment, inflation-linked bonds and commodities are the best investment channels.

We seek additional returns by adding sources of returns that do not depend on the economic cycle, but seek to exploit behavourial biases or market inefficiencies, e.g. cross-asset trends and carry. For cross asset trends, we favour markets with positive over negative momentum. For carry, we lean towards high yielding assets over low yielding ones. Historically, trend-following and carry have added value for investors over long periods of time3. And trend-following provides further diversification during equity crisis periods.

Adding additional sources of return is key to enhancing proceeds – particularly in times of sub-par returns - and in no way comes at the expense of liquidity. Instead, it helps to diversify the portfolio by taking advantage of market inefficiencies.

 

What is your approach to controlling drawdown?

All asset allocation models – whether risk-based, capital-based, systematic or discretionary - can face adverse market conditions and fail at times. In order to protect portfolios from such risks, we strongly believe in the need for built-in risk control.

This part of our process is separate from the asset allocation, and depends on a pre-determined risk budget that reflects the investor’s risk tolerance. We call it dynamic drawdown management and it is a fundamental anchor of our philosophy.

Put simply, the overall risk exposure of the portfolio can be dialed up or down based on market dynamics, always with the goal of shielding capital. This involves reducing portfolio exposure and diluting into cash as losses are suffered. We also adjust the risk exposure to capture market rebounds or to mitigate further market weakness. Lastly, we incorporate hedging strategies that seek to gain long exposure to volatility across markets in order to buffer the portfolio from sudden shocks.

 

Name three ways to best describe the multi-asset approach.

Flexible, dynamic and versatile.

 

Please find key terms in the glossary.

sources.

1Capital protection is a portfolio construction goal and cannot be guaranteed.

2Target performance/risk represents a portfolio construction goal. It does not represent past performance/risk and may not be representative of actual future performance/risk. Performance targets are gross of fees. Total expense ratio (TER) for the different share classes ranges from 0.08% to 2.34%. The S share class has a TER of 0.08%, the R share class 2.34%, the I share class 0.66%, the N share class 0.70%, the M share class 0.85% and the P share class 1.30%.

3 Source: Bloomberg, LOIM calculations. For illustrative purposes only. Past performance is not a guarantee of future results. Data from 1977-2017.

important information.

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