One of the pioneers of equity smart beta, Paris-based TOBAM, has joined the handful of competitors, including Pimco, Research Affiliates, Quoniam and Ossiam, in launching a strategy in fixed income.
TOBAM’s US credit strategy has been seeded with €30m from an existing investor and will be the first sub-fund in the firm’s new Luxembourg SICAV, Most Diversified Portfolio.
It is the first to transfer the maximum diversification methodology from equities to bonds, applying the Merrill Lynch US Corporate Bond index as reference. Maximum diversification aims to construct portfolios that maximise the ratio of their constituents’ weighted average volatility to the portfolios’ overall volatility.
TOBAM’s president and CIO Yves Choueifaty said: “We have exported the concept to most equity markets now, and the market closest to equity is credit.”
“We will look at other markets after starting in the US as the most liquid and efficient,” he added. “Expansion into other markets will be driven by client appetite, as always, and for now we are dedicated to making this strategy successful, but we have proven the portability of the concept.”
Choueifaty claims that on average maximum diversification will add 120 basis points of annual return over the benchmark, with 15-20% less volatility.
While Choueifaty acknowledges the potential for credit markets to exhibit high correlations, he argues that much of this comes from duration. The TOBAM strategy will maintain the same duration as the Merrill Lynch universe.
For similar reasons, he told IPE that the only market to which he would be reluctant to apply maximum diversification is government bonds - despite this being the focus of the first fixed income smart beta products.
“The concept depends on an understanding that market participants are rational actors, and in government bonds we have a completely irrational actor in the form of central banks,” he said.
Nonetheless, implementation in corporate bonds is not as straightforward as in equity markets. Liquidity is tighter, documentation and covenants vary from one security to another, and individual issuers often have many more than one bond, at different maturities, outstanding at any one time. Security selection is important, and TOBAM hired a fixed income expert from Société Générale in January to help in this area, once the basic applicability of the concept had been assessed.
“While selection will not diverge very much from the theoretical portfolio, this strategy cannot simply rely on the mathematics,” said Choueifaty. “Maximum diversification in equities is like flying an Airbus, whereas in fixed income it is more like flying a Cessna.”
TOBAM, which is owned by its employees, Amundi and US pensions giant CalPERS, enjoyed a successful 2013, doubling it’s assets under management. It now manages $6bn (€4.3bn). Pension funds represent more than 80% of those assets, with most coming from Switzerland, North America, the Netherlands and the UK.
The firm aims to raise its North American assets from 21% to 50%, and as part of that effort it recently announced an agreement with The Dreyfus Corporation, a BNY Mellon company, to launch the Dreyfus TOBAM Emerging Markets fund.