“Anti-Benchmark” investor eyes credit and EM
Tobam, a Paris asset manager, is preparing to launch new funds in European credit and emerging market debt, which will bring its innovative investing approach to European fixed income for the first time.
By Jon Hay – 23 Jul 2015
Tobam’s unique selling point, it claims, is an investment approach called ‘the anti-benchmark’, or ‘maximum diversification’. It also has an unusual slant on socially responsible investing.
The firm’s style is often categorised as part of the ‘smart beta’ investment trend, though Yves Choueifaty, founder and president, dislikes the term.
“I don’t know if there is a smart beta, but I know there is a dumb beta,” he says. “I don’t believe what I am doing is the smart beta — I am the beta. The benchmark has a negative alpha compared to me.”
Choueifaty had been CEO of Crédit Lyonnais Asset Management, and left in the early stages of the merger that ended up forming Amundi. He then led Lehman Brothers’ quantitative asset management business. That led to the formation of Tobam in 2006 — the letters mean ‘think outside the box asset management’. The firm now manages $9bn.
“We have only one strategy at Tobam,” said Choueifaty. “With clients we choose a universe of investments — such as Canadian equities or emerging markets. We build for this universe the most diversified portfolios — long-only, and without leverage.”
Two beliefs underlie this stance. One is that it is very difficult to forecast, since markets are quite efficient, and the definition of an efficient market is one that is difficult to forecast. So there is only one route to outperformance — to be diversified.
Tobam’s second belief is that market cap-weighted benchmarks are very far from being diversified, and in fact are skewed to certain sectors or styles. “They are systematically extremely strongly biased,” Choueifaty says. “We are trying our best to build an unbiased portfolio.”
Neither active nor passive
The approach upsets the usual contrast drawn between active and passive asset managers. Choueifaty scorns passive management as a contradiction in terms – being passive means doing nothing.
“There is no way you should be passive,” he says. “Passive has the advantage of being cheap. But you should not compare a Paris-New York air ticket with a New York-New York one.”
Passive managers, he argues, disparage active managers for failing to beat the benchmark, while charging investors more than passive funds. “But saying active managers are useless is the same as saying the average racer of the Tour de France is slow, because he cannot beat the average. The benchmark replicates the active managers, not the other way round.”
Active management is essential, as it means the application of intelligence to allocating capital, Choueifaty argues — a vital function for the economy.
But conventional active managers, in his view, hug the benchmark too closely, and thus infect their portfolios with alpha that should not be there.
The most obvious bias of benchmarks is that they increase weightings to stocks as their market capitalisations rise, as the share price climbs. This means investors are forced to buy more of stocks when they are expensive, and sell them when they are cheap.
Christophe Roehri, global head of business development at Tobam, points out the very heavy bias towards financial institution stocks that is inherent in nearly all equity indices, except US equities, which are tilted towards IT.
Fixed income indices are even worse, he says. “Most of the risk is driven by financials, and you are biased towards companies that issue more debt, which we believe does not make a lot of sense.”
TOBAM’s answer to this problem starts from the fact that a portfolio of two stocks that both have volatilities of 14 has a volatility of less than 14, because of diversification. It has an algorithm that works out the optimal combination of stocks in a given category, to achieve the best possible diversification ratio — the weighted average of the single stock volatilities, divided by the volatility of the portfolio as a whole.
“This is the simplest and purest way to measure diversification,” Choueifaty claims. “We have proved it carries mathematical properties that are very interesting. We have discovered 34 properties for this ratio.”
The technique involves minimising the correlations between the invested stocks.
The result is that Tobam’s portfolios have tracking errors — their deviation from the benchmark — of 6% to 9%, Roehri says. That compares with a typical 5% for an active equity manager.
TOBAM is not trying to pick stocks — quite the opposite, it is striving to capture the risk premium of a given asset class, meaning the return of the undiversifiable portfolio. But it ends up deviating more from the benchmark than a stock-picker. And although its style is systematic and numerically driven, it is far from the passive manager, which has a tracking error of 0%.
Choueifaty reckons Tobam can reduce volatility, compared with the index, by 20%, without having a low vol bias. “We believe we should outperform the index by 400bp a year, in returns, and underperform it between two and four years out of every 15.”
Moving into bonds
So far, Tobam has only launched one bond fund, partly because the strategy is harder to implement in less liquid markets.
However, its US credit fund began in May 2014 and has $50m of assets. “The pipeline is very significant — by the end of the year we should have $200m to $500m more capacity,” Roehri says.
The fund is 80% investment grade and 20% high yield. In the first year, it returned 4.5%, while the Merrill Lynch US Corporate and High Yield Index returned 3%, beating Tobam’s target of a 130bp outperformance.
“The benefit of diversification was reducing exposure to banking and energy,” Roehri says. “When the oil price dropped, the spread on energy bonds widened.”
Curiously, the fund avoids taking any view on duration or risk, sticking to the benchmark’s 6 year duration and its average spread, in this case 200bp. The benefits come just from diversification.
So far, Tobam has not invested in government bonds because “there are less degrees of freedom” to benefit from diversity in that market.
Emerging markets, however, offer more such freedom than credit, Roehri says. It is looking for seed funding from investors for funds in new asset classes, particularly European credit and global EM debt, and will launch them when it gets that funding.
Believing that its clients are long term investors and do not want to “burn the planet”, Tobam in all its portfolios blacklists all stocks that are barred by Norges Bank or one of Sweden’s AP pension funds. Following their lead has the advantage that Tobam is adding weight to what is already probably the most powerful voice for responsible investment choices.
Recognising that emerging market investments may indirectly prop up unsavoury regimes, Tobam donates 7.5% of the fees it makes from EM management to Amnesty International and Human Rights Watch.