Enlarging the universe
The intricacies and complexities of modern asset management, such as porting alpha and matching liabilities by using derivative instruments, should not disguise its basic simplicity. Pascal Blanqué, chief investment officer of Crédit Agricole Asset Management (CAAM), subscribes to this view. “At the end of the day, asset management is about equities and bonds,” he says.
Blanqué, a former chief economist and head of economics research department at Crédit Agricole, now heads eight investment centres worldwide, employing 530 investment professionals. CAAM’s assets under management have grown by 65% over the past three years to €479.3m at the end of 2005.
CAAM plans to sustain this growth by broadening the range of investment possibilities, diversifying within asset classes and applying niche financial instruments to mainstream asset management: “The name of the game at CAAM is to enlarge the investment universe.”
The process is already well under way, he says. “I’m a great believer in convergence of universes. At one time we used to think about the industry on a segmented basis, with different segments for structured products, hedge funds, ‘traditional’ assets, and so on. What we are now seeing is convergence of the alternative with the traditional business.”
Blanqué sees this convergence as part of a recurring process in which individual segments of the industry develop initiatives of their own, which are then shared out among the investment industry at large. “Innovation comes more often on a segmented basis, within investment banks and asset management firms,” he says. “Then comes a melting pot period, when there is a spreading of the techniques and the instruments.”
This has happened with the ‘democratisation’ of structured products and hedge fund strategies: “There is now an increasing sophistication of products, instruments and styles within the traditional business, with managers using an increasing number of new financial instruments, long-shorts, CPPI techniques, and the global macro types of product that we are seeing in the hedge fund industry.”
The greater use of structured products and derivatives has made the barriers more uncertain between the banking and asset management businesses, he says. “Everyone is talking to everyone. Investment banks are talking to asset managers, both within the same group and also within other groups."
It is also closing the gap between managers and clients, he adds. “What is going on depends on the front end of the equation, the asset managers, and the client base in terms of its knowledge of innovations."
Overall, the effect of convergence is benign, he believes. “Generally speaking it is good for the functioning of the market and the interests of the client. Anything goes now, in the sense of enlarging the universe and providing a more complete coverage of the financial cycle and the way to play it.”
The benefits of convergence are particularly strong on the fixed income side of the business, Blanqué says. Here, the growing interest of asset managers in the convergence and enlargement of the fixed income universe is matched by that of institutional investors, worried about liability matching and the prospect of rising interest rates.
“Yields are low, meaning that the constrained benchmark type bond products are not that successful today, and investors will suffer on their betas when yields rise. The solution is to enlarge the investment universe, and try to get rid of the directional side of the equation.”
On fixed income CAAM has devised a three-axis approach to this situation, Blanqué says. “The first axis is enlargement from an asset class standpoint. We have committed huge resources to credit investment, high yield, and not only the euro universe. We have embarked on a coverage of, for example, emerging corporate names.”
This also includes inflation-linked fixed income. “Inflation-linked are interesting animals because to an extent they are de-correlated with nominal bonds.”
The second and third axes, within fixed income respectively, are the enlargement of a style/product range (absolute return, long/short, CPPI,...) and geographical growth (eg, Asian bonds, US credit).
Blanqué believes that the market for inflation-liked products will grow substantially, for two reasons: “The first reason is that institutional clients such as pension funds will come to the very simple conclusion that on the core side of matching of their liabilities, probably the clearest risk they have, taking a 15-20 years view, is inflation.” Governments will issue inflation-linked bonds to meet the demand for inflation-proof fixed income products.
“The second reason is that the disinflation story is over. During the last 18 years clients and managers have been wise to stay structurally long duration in nominal bonds, as the name of the game was disinflation.”
The world has now changed and asset managers and their clients must change with it: “You cannot invent disinflation twice. This doesn’t mean that there will be a huge sell off on the bond side, but a feature of the new regime includes the fact that you cannot bet twice on disinflation. Eventually you have got to hedge or diversify your bond exposure to match your risk.”
So one of CAAM’s key recommendations to institutional clients is to diversify into new regions of the bond universe. “We thought of our product as an insurance policy,” says Blanqué . “One of the key commercial selling points for pension funds and other institutions was to tell them that this product provides them with insurance.”
Products from these new regions, managed by CAAM from London, have short durations based on Blanqué’s conviction that an eventual re-pricing of the bond is inevitable: “My belief is that a re-pricing of the bond is on the cards. This is part of the worry of institutional clients, including pensions funds. They are asking what will happen when the re-pricing arrives. We know from the past that the re-pricing of the govvies side of the equation often leads to a re-pricing of the entire bond asset class.”
Blanqué suggests that re-pricing will make life a lot tougher for fund managers. “Every fixed income fund manager has looked very wise and intelligent in recent years, because they were surfing on a trend. Over the last three years the fixed income business has turned into an arbitrage business, where managers are chasing one basis point on govvies, 2bps on credits and two and a half points on emerging.
“But the real fixed income business on a trend basis is by direction. And the fact that direction is back could be a wake up call for the industry. All the weaknesses will start to appear in this type of market. The last 18 years was largely about a beta play, and this will separate the real alpha providers from the beta followers.”
Yet there is an alternative to simply following beta that does not involve the search for alpha. CAAM’s other axis is searching for new sources of beta. “Alpha is over-bought. We should spend more time thinking about new sources of beta. There are new territories for us to enter to be able to offer a more complete coverage of the entire financial cycle for our clients.”
Clients should be looking for new sources of beta. “We must encourage institutional clients to think about new sources of beta, providing a better coverage of the financial cycle, bringing sources of diversification or de-correlation.”
Blanqué identifies housing and commodities as new sources of beta. “The regulatory framework is evolving at the moment, allowing clients to have a more interesting exposure to these sources of beta.”
Volatility is another source. CAAM has recently launched CAAM Equity Volatility, which provides pure exposure to volatility as an asset class.
Investors should increase their exposure to equities, he suggests. “The problem with equities is that there is a debate about the duration of equities. The reality is that the holding periods have diminished substantially. But equities are worth considering.”
Blanqué characterises the new investment regime as one where there are low yields across the spectrum of asset classes, but where the hierarchy of returns is still healthy.
“The big story is one of the global economy normalising after the shock and risk premia are on the way towards normality. The bond risk premia will sooner or later adjust to more normal conditions, and the equity risk premium has got to reflect this path towards more neutrality.”
The other feature of the new investment regime is excess liquidity. This is principally the result of ‘accommodative’ monetary policies pursued by central banks. These policies are likely to become permanent, he suggests. “Monetary policies will remain accommodative even though we are seeing some kind of normalisation in Europe. They will remain accommodative because central banks know the global economy is fragile, they know about the indebtedness of households, and the dependence on wealth effect. So they will err on the accommodative side of things.”
Excess liquidity is also a consequence of the actions of central banks in Asia, Blanqué says. “The banks are intervening on the FX market, buying dollars, inflating their monetary basis and therefore pouring liquidity into the global system. And they will do so in my view as long as the link with the dollar remains as it is. It may change when internal demands in Asia take shape, but this not going to happen tomorrow.”
For Pascal Blanqué, the new investment climate represents an opportunity for a multi-specialist asset manager like CAAM. For example, CAAM is currently considering building a focused and modest US credit operation by acquisition. “It is a way of signalling that intend to go global with our policy of enlarging the investment universe.”