LGIM’s Emiel van den Heiligenberg, Willem Klijnstra and John Roe on how the group’s Multi-Asset Target Return Fund achieves long-term growth through a variety of active investment strategies
WELCOME
Emiel van den Heiligenberg, Willem Klijnstra and John Roe present LGIM’s Multi-Asset Target Return Fund, a diversified asset allocation solution with a focus on capital preservation. The Fund aims for efficient risk management, particularly with respect to drawdowns, and targets a low equity beta with a cash plus 5% return. LGIM has a wide variety of world-class investing capabilities and, as Emiel van den Heiligenberg explains, this forms a good backdrop for investing in multi-asset solutions.
In today’s challenging markets, investors need to work hard to optimise their level of return in line with their risk tolerances. Faced with a low yield environment mixed with on-going uncertainty, it is little wonder fund selectors and their clients are changing how they think about investing – or indeed that asset managers have been responding accordingly with more outcome-focused, multi-asset investment solutions.
THE INTERVIEW
Multi-asset under the microscope
Emiel van den Heiligenberg Head of Asset Allocation, LGIM
Where are you seeing the best opportunities right now?
The strategy is now three years old. How has it fared so far?
How do you seek to add value over and above other multi-asset portfolios?
How did you come up with the objectives for MATR?
Willem: 2016 and 2017 were good years for the strategy. 2015 was a more challenging year because we saw a sharp reversal in market trends straight after the fund’s launch. That caught out some of the momentum strategies in the alternative component. We learnt from this episode and we’ve made small adjustments to the strategy. But we should not only look at returns but also at the three risk controls. Volatility has been within the volatility band but it has been at the low end as market volatility has been very low as well. The equity beta has averaged around 0.25 but ranging between 0 and 0.4. Lastly, we’ve only seen three equity drawdowns since the fund’s launch but in all cases MATR participated less than 40% in those drawdowns. Emiel: Despite a recent pick-up in market volatility, we don’t foresee any serious problems at the moment. Our economists believe that the near-term global growth outlook will be steady and above trend in many parts of the world. This, partnered with a broadly low inflation environment, allows for a very gradual removal of monetary stimulus, which has created a ‘goldilocks’ economic environment. One issue that has arisen from this is that asset classes are already reflecting this market positivity in their prices, while the recent fiscal stimulus in the Unites States is only adding fuel to the fire, which could end up shortening the economic cycle. Currently, we like emerging market hard currency debt on account of the yield on offer, without the stretched valuation levels that are visible in other parts of the credit market. A gradual removal of monetary stimulus allows us to continue extracting carry and roll-down from the steeper sovereign interest rate curves in the alternative component. To avoid loading on to duration we neutralise the duration exposure through shorts on the flatter curves. US inflation linked bonds are also a favourite. Despite the moderate upside, they protect against a sudden rise in US inflation which is a real asset killer, eroding equity and bond values at the same time. With the risk of an overheating US economy slowly increasing, the fund also has put in place equity protection.
To answer these needs, three years ago LGIM launched their Multi-Asset Target Return Fund (MATR). Two of the Fund Managers, Emiel van den Heiligenberg (Head of Asset Allocation) and Willem Klijnstra (Strategist), discuss the Fund’s strategy, performance and sector opportunities. Willem: MATR is a target return fund with an unconstrained investment approach. We target a low equity beta with a cash plus 5% return target. Alongside this objective, there are also three risk controls which make MATR quite unique in its kind. The first one is to manage volatility in a range between 6% and 10%, while the second is to keep the equity beta below 0.4, both over a three-year rolling period. This helps us avoid being overly reliant on equity markets. Then the third risk control is to limit our downside participation to less than 40% in any sharp and significant equity drawdown. Emiel: I have been managing money for clients in macro investing for more than twenty years. It’s one of my deep passions in life and when markets are open, I actually don’t think about much else. But I have to admit, adding value in markets is difficult and macro investing is no exception. This makes teamwork and specialisation crucial. It is impossible to be an expert in everything and it doesn’t make sense for everyone to analyse the same data or the same news item. We have a large team of experts with different backgrounds: for instance, from the IMF, central banks, hedge funds, investment banks and asset managers. We believe in specialisation. We have economists who analyse the macroeconomic environment, we have strategists who come up with the best trade ideas, and we have portfolio managers focusing on the balance of risk and return in portfolios. We believe this team approach is unique. Moreover, the LGIM multi-asset team works closely together with our colleagues in trading, fixed income and equities. And we greatly benefit from the fact that we have a world-class index capability in house. This forms the ideal backdrop for us to be successful in multi-asset.
Fund Snapshot: L&G Multi-Asset Target Return Fund
Navigating acid tests: Catalonia
What led LGIM to take this view?
The Catalonia referendum was announced in June 2017. Pre and post announcement, the MATR team closely followed the debate within Catalonia and the rest of Spain, understanding the views of the different national parties and regional parties. As a result, MATR has held various Catalan exposures over the past few years. The Fund moved into short-dated (less than one year) debt in October 2015 after the first independence scare. The investment team then bought longer-dated (two to three year) debt in March 2016, then again in August 2017 in the lead-up to the referendum result. The bonds continued to weaken until shortly after the referendum on 1 October, but have since fully recovered to pre-August levels. These positions are still held today. 1. There are significant legal hurdles to independence. 2. Most Catalan citizens have a pro-European stance. 3. The market underappreciated the extent of the official backstop for Catalan debt. The ECB is an active buyer of sub-sovereign debt across Europe (including Catalonia) through its asset purchase programme, and the main creditor of the Catalan government is the Spanish state via the Financing Fund for the Autonomous Regions (FFCA). These two backstops significantly reduce Catalonia’s refinancing risk. 4. In addition, negative interest rates in Europe make it unusually attractive to hold currency-hedged European debt despite the low headline yields.
* Fund inception date 20 March 2015.
Source: LGIM. Chart shows bid-to-bid performance since launch date of the L&G Multi-Asset Target Return Fund to 30 March 2018 for L share class, which is an internal share class used to illustrate the strategies full history, not available for external use. Past performance is not a guide to future performance.
Source: LGIM, Bloomberg as at 30 March 2018. Fund inception date 20 March 2015.
MATR risk targets
John Roe, Head of Multi-Asset Funds, LGIM
VIEWPOINT
Battling behavioural biases
Understanding how the mind can help or hinder investment success is a cornerstone of successful fund management. Increasingly, investors are using knowledge about investment biases to design better investment solutions and gain an advantage over the rest of the market. In this vein, one of the key philosophies driving MATR is the group’s emphasis on disciplined investment thinking. The managers don’t rely on external research and they also take measures to combat groupthink; to achieve this, they have a 25-strong team of experts that work together within a structured investment framework to develop independent views. Here, John Roe, Head of Multi-Asset Funds at LGIM, details the actions the team embeds into the investment process that help to combat behavioural biases and mental shortcuts: a flexible team, structured decision-making and dedication to improving confidence calibration.
3. THE CALIBRATION GAME
Even with a flexible team and structured investment process, we need to ensure our decisions are rooted in evidence. Unfortunately, this is not as simple as it sounds. People are naturally overconfident in their judgement calls and therefore not very good at assessing the likelihood of different outcomes. This is partially due to base rate neglect and it occurs when there is a discrepancy between an event – say, a fund manager outperforming – and how likely people assess said event. So how do we tackle this predisposition? Calibration training helps us assess individual members of the team in terms of how overconfident they are and ways in which their approach may be flawed. This training is essential to reinforce how difficult it is to beat the average decision-maker, increase self-reflection and, in turn, help the team become more aware of their individual biases No silver bullet: We have only highlighted a small handful of biases here. The reality is, there are many more – too many to address individually. That is why we have shaped MATR’s investment process to limit their impact. Alongside our tactical investment views, we also allocate risk budget to taking medium-term positions and use market signals to propose trades, so that we can filter out short-term distractions and biases.
2. GUT EXTINCT
Humans are subject to a constant internal battle between logical deliberation and gut instinct when making decisions. Unfortunately, the latter often wins out. Fast, instinctive thinking may be easy, efficient and feel natural – but when it comes to investing, it is not generally conducive to success. Gut instinct is driven by many biases, but there are two we pay particular attention to. Availability bias leans us towards the information that is most widely discussed and readily available. In other words, material that has more profile – notwithstanding its relevance – will have more bearing on decisions. Recency bias affects us in a similar way: because we have a tendency to overemphasise whatever has just happened, recent events unduly influence us. Avoiding survival of the most obvious: When assessing the investment landscape, we have a structured process in place to limit the risk of focusing too much on certain features of an investment opportunity at the exclusion of alternatives or contradicting evidence. We use scorecards to map pre-agreed criteria such as valuations and investor sentiment across wide range of assets. This forces us to objectively assess new information on existing trades that may otherwise have been subconsciously filtered out. In doing so, we are able to compare investments consistently. Scorecards also help us tackle confirmation bias in the team. People tend to think they are right, and so dismiss information that contradicts their position while using less useful information to justify it. Surveying the landscape: Our five economists map out their roadmap each month, with an outlook for growth and inflation over the following year or two. While that generally represents our most likely scenario, we need to give due attention to alternatives or else we risk overly focusing on one outcome which in reality we often only see as have a 30-35% chance of occurring. In addition, the more people discuss a scenario, the more likely they generally believe it to be and the time spent on the full range of alternatives helps counteract that.
1. FLEXIBLE FRIENDS
Diversity of thought is central to effective decision making, and as such it is an important argument for greater diversity in investment teams. It is not enough to just hire the right people, however; teams must also make the most of every person, which means ensuring all voices are heard. But that is easier said than done. Large groups are predisposed to a number of biases: authority bias, for instance, whereby decisions are overly impacted by senior individuals; or shared information bias, when more time is spent discussing topics with which the group is already familiar, encouraging a narrow focus and consensus views. Musical chairs: To limit the risk of overemphasising the most senior views and biasing the team towards how those views are framed, we rotate the chair person at our weekly brainstorming meetings and encourage topics from across the team. For similar reasons, we also rotate who contributes to certain parts of our investment process. The agenda also changes to help combat anchor and adjustment problems, where the first item of the day tends to become overemphasised (the anchor) and insufficiently deviated from (the adjustment). The stupidity of crowds: The benefit of group decision-making is often lauded as ‘the wisdom of crowds’. The average guess from a crowd of people for the number of jelly beans in a jar tends to be close to the correct number, even if many individual guesses are poor. When it comes to investing, however, market pricing already reflects the average view of thousands of investors. Crowd-based decision-making within the team leads to very similar views and stops us from finding mispriced opportunities. With this in mind, we implement flexible, diverse and small (3-6 people) investment discussion groups that are likely to yield different perspectives on the issue in question.
(l-r): Lars Kreckel, Global Equity Strategist; Willem Klijnstra, Strategist; Hetal Mehta, Senior European Economist; Chris Teschmacher, Fund Manager; Emiel van den Heiligenberg, Head of Asset Allocation; Simone Nascimento, Strategist; John Roe, Head of Multi-Asset Funds; Aimee Bowkett, Asset Allocation Product Specialist
MEET THE TEAM
Find out more at www.lgim.com
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