Aviva Investors

Using macro and fixed income strategies to generate alpha

Originally published in the September/October 2012 issue

Aviva Investors is the asset management arm of one of Europe’s leading providers of life and general insurance overseeing assets of over $400 billion. Nestled within it is the absolute return business running three hedge fund strategies with combined assets under management of $1.3 billion. Shahid Ikram, Chief Investment Officer and head of fixed income, is the portfolio manager of the hedge funds and has a 22-year track record with the firm.

Ikram’s macro view is that monetary policy will remain very loose for a considerable period of time. The policy’s impact is already apparent in the front end of the yield curve with rates near 0%. But Ikram believes there is room for rates further out on the curve to fall as long-term investors chase yield. He is short the euro, the RMB and sterling, being long the dollar, but as a refuge from quantitative easing in the UK and eurozone and as a safe haven in the event of a policy mistake or a sudden ‘Lehman’ moment. “We are very much in the camp where we feel the size of the debt burden on a global basis will result in lower growth than equity markets are currently pricing in,” Ikram says. “It will be a constant feature of the next five to 10 years where the need for austerity and deleveraging will result in a continued shortfall in economic growth. Alongside this central banks will remain concerned about the prospect of debt deflation from deleveraging. As a result markets will remain buoyed by central bank liquidity.”
Post-2008 Ikram has noted a number of fundamental changes. Economic cycles have become shorter and subject to more volatility. What’s more, the central bank-supplied liquidity won’t find its way into the real economy. Consequently, equities valuations will be higher than the level of economic growth would justify. This outlook suggests two trades. With yield curve flattening and an absolute fall in long end rates to come, one trade is to be long swaps though options positions. Meanwhile, with stock markets not discounting the growth shortfall, Ikram has bought options going long volatility and establishing put spreads on a number of equities markets.
Aviva Investors’ biggest strategy is the G7 Fixed Income Fund with AUM of $682 million (as at 31 August 2012). It is positioned to have about 70% of its exposure in relative value trades using yield curve and swap spread positioning. The remainder of the exposure is invested in macro directional trades in rates and short end positioning. It has a nine-year track record (See Fig. 1) with an annualised return of 9.9% and very low volatility of less than 3% since inception (February 2003).

“We only target institutional investors,” says Raphaelle Moysan, a client portfolio manager. “It is very attractive to pension funds and insurance companies who are looking to find a bond substitute of steady returns with low volatility. The strategy offers low correlation to traditional asset classes, notably the equity and credit markets, and there is a diversification benefit.”

The Macro Fixed Income strategy flips around the exposure so that 70% of the book is invested in macro directional trades with the remainder of the exposure put into relative value trades. It is running $549 million four years after inception during which time it has generated annualised performance of around 7.3% with annualised volatility of 5.6%. The positioning of the two strategies is quite similar. What is different is the sizing of the positions. Both strategies draw allocations from institutional investors, but Macro Fixed Income has found a niche with family offices.

Avoiding credit, equity market beta
The target is mid-to-high single digit percentage returns with low volatility. Ikram aims to get away from credit and equity market beta and doesn’t want to be structurally long duration. Risk is deployed around five investment themes that are lowly correlated – three that are directional in nature and two that are relative value. The mixture, Ikram says, provides a natural balance and if one theme doesn’t work he expects it will be counterbalanced by the other themes.

Ikram emphasises Aviva Investors’ strong focus on capital preservation. “Among hedge funds we are among the most risk-aware,” he says. “I’m an asset manager whereas many other hedge funds are ex-investment bank prop traders. I focus on high Sharpe opportunities. We want pure alpha and stay away from leveraging beta. Many people talk about this but we are really doing it.”

In 2008, the G7 strategy had its best year, returning 16.19%. Returns have been dampened in 2012, but the fund was up 1.15% to end-August and has only had one losing month – June , when it lost -0.29%. “This year has been a challenging year,” says Ikram. “So far we have managed to avoid losing money and we are in the first quartile. That is how you prove you are preserving capital and delivering pure alpha.”

To Ikram’s mind, Aviva Investors clear edge is its investment process. This is combined with getting clarity on global macro economic prospects. There is a team of five quantitative analysts who develop proprietary models and look for points of inflection in the GDP cycle. “We are always doing valuations for mispriced assets with a top-down forward-looking economic outlook,” says Ikram. “We look for where the risks are and where the changes to the status quo are likely to take place,” using both statistical analysis and real asset prices.

“Running a hedge fund in an institution like this is a huge advantage,” says Ikram, noting that he can access actuarial, cash flow and liability-focused analytical models. The aim is to understand when and why a market is expensive. The heads of the various asset classes engage in scenario playing exercises once a month. There is also work done on long-term valuations and on identifying hedges for different liabilities.

Though Ikram’s credentials are in pure relative value, he is adept at embedding tail hedges in the portfolios. He also looks for early warning signals on risks and for the optimum time to hedge those risks.

“What we are trying to capture is where we are going and at what speed,” Ikram says. “It is question of indentifying these opportunities when they are still out of the money and cheap.”