Lombard Odier Pension Fund has developed an innovative multi-asset approach based on absolute return and diversification, finds Carlo Svaluto Moreolo
At a glance
• DB pension fund for employees of Lombard Odier
• Assets: €1.3bn
• Location: Geneva
• Founded: 1910
• CIO: Aurèle Storno
• Strategy: outcome-oriented, risk-based, multi-asset portfolio
The Lombard Odier Pension Fund is probably one of the oldest private pension schemes in Europe. A pension scheme for the private bank’s employees was set up in 1910, according to the bank. Today, the €1.3bn defined benefit (DB) fund aspires to be at the cutting edge of institutional investment. It is run by means of a risk-based, multi-asset strategy that presents an alternative to both risk-premia approaches and traditional multi-asset approaches.
The pension fund’s assets are run internally by Lombard Odier Investment Managers (LOIM), the private bank’s asset management arm. The assets are pooled with more than €3bn of assets managed on behalf of external clients as part of LOIM’s multi-asset business.
Aurèle Storno, the fund’s CIO, also works as asset allocation and portfolio management specialist for LOIM. According to him, the way the Lombard Odier Pension Fund is managed today is the result of a great philosophical change. The change took place within the company at about the time of the global financial crisis of 2007-08. At the time, the pension fund’s board was concerned about performance and the fund’s coverage ratio. The fund, which was managed with a more traditional multi-asset approach, was beating its benchmark, but was not delivering in absolute terms. It was also erratic in terms of its coverage ratio. “There was a big risk on the asset-liability management side,” says Storno.
In general, the Lombard Odier Pension Fund’s problems are similar to those of its peers. Storno adds: “We need some liquidity, which bonds are not providing. Holding cash is problematic. We still want to preserve capital over a short to medium time horizon because of our balance sheet, and we need to find growth elements to boost returns.”
The fund’s investment philosophy consists of departing from the traditional multi-asset approach towards a risk-based framework. Storno uses the expression ‘outcome-oriented investment’ to describe the approach, and points out that risk-based is fundamentally different from risk factor-based. “Risk factors, or risk premia, is about what you invest in. Risk-based is about how you invest,” says Storno.
Beating a benchmark is not the fund’s primary objective. This sets the fund apart from most of its Swiss peers, which are heavily benchmark-oriented. The primary objective is delivering a target return, currently set at cash plus 4%. Until recently, the target was cash plus 3%, but it was raised to reflect the negative rates on cash that are prevalent in Switzerland today.
Second, the pension fund has set a risk budget that equates to a 14% maximum loss over 12 months. However, the confidence levels built into the model are so high the fund should not expect to lose more than 10% on a given year. To keep within this risk budget, the fund has to maintain a strong focus on diversification of risk, which represents the one of core principles of the investment philosophy.
Perhaps the most distinguishing feature of this approach is that there is no asset class optimisation involved. The fund focuses on assembling a diverse set of return streams that are uncorrelated and driven by different fundamental forces. Storno explains: “We try to put together hopefully a large number of return sources that are either statistically diversifying from the point of view of correlations, or diversifying because fundamentally they are not driven by the same patterns.”
The choice of return streams is based on cautious estimates. “If we put together different return streams, either driven by fundamental or behavioural forces, based on cautious estimates of what they may deliver in the future, we can build a more robust portfolio,” says Storno.
The essence of this outcome-oriented, risk-based, multi-asset approach is a focus on return streams, time horizons and liquidity. With respect to these core elements of portfolio construction, the fund considers on the function of each asset class.
The first pillar of the portfolio is an allocation to traditional and alternative risk premia in equities, sovereign and corporate credit and commodities. This strategy is coherent with the All Roads strategy that LOIM provides to institutional clients. The allocation provides liquidity that bonds or cash cannot provide, according to Storno. In terms of risk management, it has delivered positive returns close to 95% of the time, looking at any one-year period.
“The objective of this strategy, which is delivering 4% over cash, is to control risk by diversifying into in extremely liquid risk premia, with emphasis on traditional ones and alternative ones. It is very dynamically managed, but purely systematic,” says Storno.
Then the fund seeks capital preservation, yield and liquidity in fixed income assets. These characteristics can hardly be found in conventional fixed income assets and strategies. As a result, the fund focuses on corporate credit with a strict buy-and-hold approach. There is little duration exposure in the fixed income portfolio, says Storno, and the holding bonds to maturity gives yield predictability. The attention is turned instead on mitigation of default risk, a task entrusted to the company’s internal credit research team. The credit investments represent 15% of the strategic asset allocation.
The fund also invests a relatively large part of the portfolio in insurance-linked securities (ILS) sector, which Storno says can yield between 4% and 8%. A real estate portfolio focused on Swiss properties is also providing yields above the pension fund’s target return. Finally, there is a 2.5% allocation to infrastructure. These represent the yield-boosting part of the portfolio.
The growth-oriented part of the portfolio consists of developed equities, emerging market equities, convertible bonds and emerging market local currency debt. There is also a more illiquid part, primarily consisting of private equity investments. “We mix these strategies because you need diversification to achieve long-term returns. The allocation is pretty stable. We don’t do any tactical allocation at the pension fund, as we believe it doesn’t add value.”
So far, this strategy has achieved its target, with a maximum loss of 3.7% and a Sharpe ratio of 1.5 since its launch. This is despite several market shocks that have hit Swiss investors over the past seven years.
Storno says: “This is what risk-based, highly diversified means to us. It means high efficiency and controlled drawdowns. It may take some time to convince Swiss and foreign investors that this is the right approach. There is a tendency to focus on benchmarks, but comparing this strategy to a traditional benchmark is not helpful. However, we now have a track record of eight years and we have successfully introduced several return sources”.
Perhaps letting go of traditional benchmarks will prove to be a successful strategy for many other Swiss pension funds.