Lombard Odier Darier Hentsch, the 215-year-old Geneva-based banking group, is, of course, a family business. It is just happy coincidence that both the father and brother of Hubert Keller, who co-heads the institutional asset management division, Lombard Odier Investment Managers (LOIM) alongside Thierry Lombard, spent parts of their career with the bank: Keller says he never came across it during his years on the sell-side in London, before joining in 2006.
But as one of the seven managing partners in its unusual unlimited-liability structure who personally meet all of its regulatory capital requirements, he certainly feels the responsibility of stewarding a family heirloom.
“We regard ourselves as trustees,” he says. “We have to be able to pass the firm on from one generation to the next. It’s a culture of long-term focus, with a time horizon that is very different from that of a publicly-quoted firm.”
Or even, arguably, of a limited-liability partnership. LOIM’s managing partners put their entire net worth on the line, every year, when they sign their partnership contracts.
But ‘long term’ does not quite do justice to this culture. Keller talks about business and investment strategies that take a 10 to 15-year view. But he also knows that if you sit and wait 15 years for the market to do its magic, it’s unlikely that you will have an asset management business to pass on to the next generation at all.
“There are basically three ways to generate performance from markets,” he says. “There is beta; there are uncorrelated returns, or alpha; and there is an illiquidity premium. Over the long term, market beta is probably the most attractive but, of course, the problem is how to cope with the volatility of those returns, particularly in an environment like today’s, where things are profoundly and fundamentally changing. We live in an over-sophisticated financial world that tends to amplify the underlying economic cycle, and will therefore have to live with much more frequent and severe market crises.”
Sound familiar? Many of Europe’s defined benefit pension schemes face liabilities whose duration also falls around that 10 to 15-year horizon. Everyone under the sun likes to tell them how they should be behaving like ‘long-term investors’. But most have cash flows to meet today. And even those that do not face pressure from accounting or regulatory regimes to manage their assets as if they do, or from sponsors who want to offload those liabilities long before their due dates. They cannot afford simply to ride out market volatility.
This is why Keller is excited about bringing the LOIM philosophy to more of the institutional investor community. LOIM still represents just 25% of total group assets against Lombard Odier’s core private client business. The long-term aim is to raise it to an equal contribution of group cash flows, while limiting assets from the group’s ‘captive’ private clients to about 15%. Shorter-term, a 2010 objective to grow AUM from around CHF35bn (€28bn) to CHF50bn within three years is nicely on course. But even within LOIM, the client base remains largely continental European - and half of those are Swiss. A bigger effort is planned for the UK and US - where the New York office is expanding to target large institutions with LOIM’s alternative strategies; new sales offices have recently opened across Asia; and there are plans for a Middle East presence.
Is LOIM relevant to these institutional investors? It certainly puts its money where its mouth is - in more ways than just the partnership structure.
“Two years ago we decided to completely revamp the investment approach of our own, CHF1.2bn (€1bn) pension fund,” says Keller. “We were in the same position, in terms of our coverage ratio and the way the portfolio needed to be changed, as so many other pension funds across Europe. In the past, we operated, like most of our competitors, according to a very traditional model - strategic benchmarks and asset allocation, with tactical bets. The whole industry can only be disappointed with the performance of that model over the past 10-15 years. Things need to change, and it’s always easier to begin the discussion with what we ourselves have done.”
What LOIM has done, in short, is to focus on developing more optimal and sustainable sources of market beta, and then work on separating that beta from alpha (and illiquid assets and strategies) in its risk-manufacturing teams and processes.
“For our own pension fund we’ve taken the view that 25-30% should be in illiquid assets and that the risk contribution from the rest should be split two-thirds in traditional beta and one-third alpha,” says Keller.
The beta side of the equation comes in two forms. In multi-asset portfolios it essentially means risk parity - making sure that capital allocations result in roughly equal contributions to volatility from each asset class (with some adjustments based on the overall market volatility regime). In bond portfolios it is about adopting fundamentally-weighted (rather than market-cap weighted) benchmarks. Both measures are designed to help long-term investors smooth out some of the bumps in the road; risk parity will tend to ease you into less risky assets when market volatility rises (and vice versa), while fundamental-weighting will tilt you away from the overpriced securities that dominate cap-weighted benchmarks, and generally offer more diversification for the same tracking error.
“That’s been our way of sustaining, over a long period, traditional beta in a portfolio,” Keller explains.
Then there is the separation approach. “In any brief that we manage, we want to be able to offer ourselves, and our clients, complete transparency about where risks are being taken and performance is being generated,” says Keller. “We want to be able to say to our clients: ‘Your portfolio is up x%; the beta part was negative, and the systematic and credit parts of the alpha contribution were positive and the fundamental stockpicking part of the alpha was negative’.”
To do that, Keller is convinced that those two basic elements have to be manufactured independently. But he also thinks that it optimises practice in both alpha and beta creation, by avoiding confused and contradictory objectives.
“Alpha is culturally different from beta,” he says. “In alpha generation we want people who hate to lose money, who are driven by P&L and sourcing return in any market. You think markets are going to be difficult? You know what, you can convert 100% of your alpha portfolio to cash.”
Of course, managers of traditional, benchmarked active strategies who decide that the alpha opportunity is poor will hug their benchmark - essentially choosing not to allocate risk or capital to alpha in the same way that Keller describes. And while all of its fixed income and multi-asset offering has made the change to the new principles, LOIM does still offer these kinds of traditional, alpha-plus-beta products with cap-weighted benchmarks in a number of equity strategies. But, as he makes clear, it is not the shape of the ultimate product that matters here so much as the manufacturing process behind its constituent parts.
The extent to which purification of objectives improves the creation of either alpha or beta is debatable - it probably depends on the nature of the individual asset class and strategy. But what is not debatable is the fact that separating the two at the manufacturing stage makes it much easier for an institutional investor to choose one or the other from LOIM without resorting to cumbersome and expensive portable alpha structures. The advances the firm has made up to now suggest a longer-term direction towards this kind of tailored solution for such clients.
“The business we have done like this so far is small, but it is the direction we want to go in,” Keller confirms. “Step one was the manufacturing project; step two was how we align that manufacturing with our product range - which we have made good progress on; the third step is to be more pro-active in discussing how we design solutions for institutional clients.”
Can it succeed? Alpha is alpha - that will depend entirely on the talent LOIM can bring to market. Can its beta and ‘smart beta’ compete with the products on offer from the quant giants out there? That’s a tougher proposition. But in either case, the firm starts from a modest base and has a long way to grow.