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Quantitative route to effective decision-making

The BPI Valorizacão Pension Fund’s investment strategy has been heavily influenced by the new company chief investment officer’s hedge fund background. He wanted to implement a model that would allow the pension scheme to have more consistent numbers and minimise negative performance periods. He concluded that traditional emotion-driven quantitative decisions were not delivering very good results and decided to adopt a dynamic quantitative approach that would lead to quick and objective decision-making.
Portfolio diversification is very important to BPI’s new tactical asset allocation model. The model comprises 12 quantitative strategies for different asset classes including equities, fixed income, credit, currency and duration management. These strategies are then divided into three groups based on price-driven, macro and market sentiment. Price-driven strategies are guided by market prices. (These strategies can either be based on momentum or mean reversion, depending on BPI’s understanding of the asset’s behaviour.)
Macro strategies react to specific economic indicators in an objective way while market sentiment models produce buy and sell signals based on the evolution of certain indicators or asset classes that access the market’s level of risk appetite or aversion.

To implement this asset allocation model, the pension fund has put together a team of eight people of very different backgrounds. The team includes three mathematicians and two engineers, who have built sophisticated algorithms for the scheme’s models. Although BPI’s models have a simple and understandable economic rationale, the scheme likes to use these tools to maximise its range of choices and to achieve greater efficiency in its research for new strategies. BPI has a scientific approach to research. The research process includes observation of financial market behaviour, analysis of behavioural patterns, hypothesis construction via quant models, experimentation using back-testing models and conclusion leading either to implementation or rejection.

Highlights and achievements
As at 30 September 2005, Fundo de Pensões Aberto BPI Valorizacão was valued at e56.4m. Last quarter, the pension fund raised its exposure to interest rate risk by increasing the duration of the portfolio.
The pension fund’s risk level is classified as moderate. Its benchmark comprises a central value of 25% in equities. By law, the exposure in this asset class cannot exceed 55% of the total portfolio.

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