Amplifying alpha 

Overdrive was named after the English MGB sportscar that Lauri’s grandfather drove. It has a two-speed gearbox acceleration feature that increases speed and power. The Overdrive strategy also ups the ante of its portfolio managers’ ideas. The objective of the fund is to leverage the alpha generated by minimising exposure to other risk factors. Overdrive goes up to 400% gross exposure with a volatility target slightly above 5%.  

The fund has 3 sources of performance: the alpha generated by the long/short positions set up by the fundamental portfolio management team, the yield contribution from the fund’s cash position, placed at risk-free rates, and the tactical measures put in place by the lead portfolio manager to optimise risk management and enhance alpha generation. Each source contributes differently in terms of risk, with alpha representing around 80% and the tactical initiatives around 20% of the total risk.

The big picture performance objective is to at least match long run average equity market returns of around 7% per year, with lower volatility. Historically, the strategy has delivered circa 75% of European equity returns with circa 30% of the risk over a period when interest income has contributed nothing positive until 2022 on the 100% cash weighting, which arises because short sale proceeds finance longs. Had interest rates been 2.5%, Overdrive would have met its return target.

The arithmetic behind the target is to generate about 2% of gross alpha per 100% of gross exposure, adding up to 8% of alpha, plus returns on cash, minus fees. The target is over a full cycle and the annual alpha per 100% exposure has varied between approximately zero and 3% over the life of the fund.

Drivers of the opportunity set

Between 2013 and 2017 Overdrive annualized at nearly 10% despite sub-zero Euro interest rates, and was thus making about 3% gross alpha, before fees, per 100% exposure. Lauri recalls, “This was generally a good environment for equity long/short and equity market neutral strategies on a fundamental basis, as seen in the HFR or Credit Suisse indices”. 

Overdrive then trod water between mid-2017 and mid-2020, partly because, “The portfolio managers had too much exposure to value and value mean reversion strategies,” Lauri points out. The last four years, between mid-2020 and mid-2024, have averaged mid-single digit returns, in the middle of the two previous periods.

The opportunity set will fluctuate with considerations including stock dispersion, whether stocks are being driven by fundamentals, and portfolio managers’ alpha generation. “For instance, volatility driven by a macro event such as the Eurozone crisis makes it more difficult to extract alpha from sector pair trades. 2020 was positive due to high volatility and fundamentals driving dispersion, whereas 2021 was more difficult due to low volatility and capital flows becoming more important than fundamentals,” explains Lauri. The firm’s newsletter is completely candid about the lack of alpha generation in 2023, when most of the returns came from cash and tactical overlays.

Manager turnover and capital allocations

“Complacency over the efficiency of portfolio managers’ decisions is the worst thing in our industry,” says Lauri. Managers are hired from other asset managers and/or can be sector specialist analysts; most work alone but some can be supported by an analyst. Turnover of managers fluctuates mainly with their performance and underperforming managers can be asked to leave with an arrangement and compensation package under French labour law. Over the past three years, 2021-2023, manager turnover averaged 10.6% but it increased to 27% in 2023 after a dearth of alpha. In the past 15 months, five managers have been removed and five added: two junior and three senior portfolio managers. “We are very happy with the new team,” says Lauri.

Different from US multi-strategy giants

The culture is very different from the US multi-strategy pod model giants: “There are no Chinese walls. The PMs do not sit in siloed pods. There can be some small universe overlap and in any case they can discuss stocks with some constructive brainstorming confrontation,” says Lauri. “It is also more of a long-term investment culture and less of a short-term trading risk culture. We have owned some longs such as Stellantis, Publicis and ASML for years, though we have also profited from shorter term trading. Some short positions have also been held for a long time: small French tech Atos was down over 90% and we stayed short,” says Lauri. Portfolio turnover averages five times a year, with average holding periods around two months, but this includes some trading around core positions.

Earnings days alpha fest

Whereas some of the US multi-strategy firms cut positions before earnings, Exane Asset Management never do so and for good reason. Lauri explains: “Around 30% of our alpha generation has been on the day of earnings releases. This comes from both beats and misses and market reactions. However, we do not take positions specifically for the earnings’ release. This is great alpha, but it is only 4 days per year per stock”.

Style, factor and beta limits

Exane Asset Management’s factor exposure limits may also be wider than those of some US multi-strategy platforms. “We consider factor correlations of up to plus or minus 25% to be acceptable, while anything breaching these limits will be investigated. Realistically, 80% of our returns should be idiosyncratic, stock-specific risk, while factor exposure is 10%, and country exposure around 5 or 6%. It is counterproductive to be country neutral,” argues Lauri.

In general, the strategy has not been sensitive to style and factor rotation, but at the end of 2020 the portfolio managers’ analysis revealed a very marked asymmetry which led them to buy the Covid losers that discounted very limited hopes of recovery, covered by the Covid winners. This also coincided with an unusually high net long, which averaged 6-8% between March 2020 and March 2021 against 1% since inception. 

“We would never go above 10% net long or 5% net short, but after a 45% drawdown in equities we wanted to be a bit contrarian,” recalls Lauri. The Covid period net long was not a top-down call but was all derived from bottom-up stock views. “We were not sure of a strong rebound, but there was huge asymmetry with the worst world priced in. We do not spend much time on top-down views and would generally try to avoid this sort of exposure,” says Lauri. 

Sector pairs trades

Overdrive has around 300 stocks, split between longs and shorts, and spread across 12 or more portfolio managers.

Nearly all industrial sectors, typically 90-95%, are potentially covered, but it does depend on additions and deletions of portfolio managers, whose coverage appears on the Exane Asset Management website. Any omissions are not a problem for a market neutral strategy, and currently the mining sector is not traded.

At least 80% of the trades are sector pairs. Small net longs or net shorts in sectors may result from a portfolio manager’s willingness to have a slight exposure or it may depend on sector definitions: “It is broadly sector neutral but small exposures can arise from e.g. MSCI classifying Novozymes as chemicals while Stoxx classifies it as healthcare. Occasionally, PMs may also adjust these two providers’ sector definitions, depending on their perceptions of stocks,” explains Lauri.

Nearly all shorts are in single stocks, though portfolio managers do have some small freedom to use sector indices, but no longer national indices. 

One exception to some of the narrowest definitions of “sector pairs” is an asymmetry in ESG restrictions. ESG exclusions apply to longs but not shorts, and Exane Asset Management has been short of a gambling name in France. This could not be paired against a long in gambling but could be partnered with something in a more broadly defined “leisure and entertainment” sector. 

The long book exclusions are: controversial weapons; tobacco, gambling and pornography above 10% of sales; coal above 10% of sales and firms not compliant with the UN Global Compact principles. These are typical of a large European manager, though some other managers also exclude these activities from their short books.

Quantitative

The stock selection is almost entirely discretionary, but Lauri initiated a small quantitative strategy using 5% of Overdrive in 2024. It aims to both generate alpha from e.g. earnings revisions or price momentum, and correct any factor biases, of which long volatility and short momentum are currently being addressed. An internal quant model rather like Barra is used to assess the exposures. “The strategy has always had a strong framework of quantitative analytics, so the quant strategy is not really as new as it sounds,” points out Lauri, who studied Mathematics and Actuarial Science. 

Tactical overlay

Separately, the tactical overlay can also either increase or reduce other biases through top-down geographic rebalancing and bottom-up position level changes. “Our managers have a ‘home bias’ to being long of French and Eurozone names, and being more short of UK, Swiss or Nordic names. Although our managers have generated more alpha from the Eurozone, we intervene to reduce net long Eurozone exposure from about 30-35% down to 15-20%. The Eurozone net long is also reduced due to potential political fragility, the Eurozone can be bad in a crisis,” he points out. The tactical overlay is also currently eliminating US listed stocks, which never anyway exceeded 10 or 15%.

Lauri is additionally making some shorter-term bets on some managers’ stock picks. “We might increase a 1% position to 1.35% for two weeks and then reduce it back to 1% again. I want to leverage the quality and timing of the team to extract more alpha.” 

The tactical measures have contributed a lot over the past two years: over 2% in 2023 and 2022, with a 1.5% volatility target, but he is certainly not doing victory laps. He remains very much focused on improving the core return driver of portfolio manager alpha generation. 

Going forward, Lauri is constructive on the outlook. Cash is earning over 3%, and he is confident in the enhanced alpha prowess of the team including new recruits. Exane Asset Management are of the opinion that the historically high mid-teens returns from long only equities over the past few years are unlikely to be sustained, and timing is good for an equity market neutral approach.

Exane Asset Management’s firm-level assets have to some degree followed its alpha performance in the rear-view mirror, peaking above $5 billion in 2017. Assets now around $2.56 billion at year-end 2023 leave plenty of room for growth from investors who see a better climate for alpha generation ahead.