Natixis Conservative Risk Parity received The Hedge Fund Journal’s 2021 UCITS Hedge award for best risk-adjusted returns in the risk parity category over the seven years to December 2020. The Natixis multi-asset investment process adds value and generates alpha across a variety of absolute and relative return strategies and mandates. The multi-asset team in Paris now groups strategic asset allocation, tactical asset allocation and manager selection of affiliate and third-party funds all under one umbrella. “Natixis Investment Managers Solutions has merged three businesses – French multi-asset solutions, structuring and portfolio research and consulting – which hitherto sat inside affiliates, because it makes more sense for them to be done at the Natixis level and not affiliate level,” says James Beaumont, Managing Director & Head of Multi Asset Portfolio Management at Natixis Investment Managers Solutions.
We blend macroeconomic and technical analysis as well as behavioural finance and monitoring of sentiment indicators such as consensus positioning.
Pierre Barral, Head of Flexible and Absolute Return, and Head of Multi-Asset Portfolio Management (MAPM), Natixis
Assets under management and advice are around EUR 50 billion, which includes funds, separately managed accounts and advisory mandates. Most of the assets are in customized, bespoke client mandates and are run with semi-open architecture. “The twenty-plus affiliates manage 90-95% of the assets, but there are exceptions where fee constraints or client preferences require other managers to be used, or if affiliates’ strategies are otherwise not appropriate,” says Pierre Barral, Head of Flexible and Absolute Return, and Head of Multi-Asset Portfolio Management (MAPM), at Natixis Investment Managers.
Mandates can be geared towards a range of absolute and relative return targets as well as specialist objectives such as life cycle products. Some may restrict the investment universe to fixed income or European markets while others invest across all asset classes or globally. Some mandates are implemented via ETFs rather than funds.
Advisory mandates are an important growth area. “They cater for smaller and medium sized wealth managers, who want to outsource their portfolio construction and fund selection process while keeping control of brands and client relationships. In some cases they may even blend their own fund buy-lists with ours or put their own brand name on a white label product managed by Natixis,” says Beaumont. In advisory, Natixis sometimes competes in beauty parades against OCIOs or investment consultants.
Around 90% of assets originate from France, including two very large advisory mandates not included in the headline EUR 50 billion figure, but the business is attracting mandates overseas from Italy, Taiwan and Latin America, as portfolios have generated material outperformance.
The active, discretionary fundamental macro investment process is an eclectic one that combines traditional and modern analytics: “We blend macroeconomic and technical analysis as well as behavioural finance and monitoring of sentiment indicators such as consensus positioning. It is important to detect when markets are oversold on a short-term basis, in addition to pure macro analysis. Quantitative techniques are of course used for risk management, and financial engineers construct portfolios based on quantitative risk,” says Barral.
The word ‘conservative’ in the fund’s name is sincere. It is highly unusual in employing no leverage.
A quantitative team and a separate macro team determine long term strategic asset allocation, which provides model portfolio benchmarks for funds and mandates. Tactical asset allocation is adjusted monthly and draws on different teams. The Cross Asset Team (CAT) committee selects the best intra-asset class ideas from seven tactical asset allocation teams, who specialize in certain asset classes or geographies, such as fixed income, foreign exchange or emerging markets, or who focus on technicals or behavioural factors. “The aim is to exercise discretion to select best ideas, rather than to apply a weighting to them,” says Barral.
Many portfolio managers use the model portfolio as a foundation, calibrated to their benchmarks, but also have freedom to deviate from it – both to meet the risk and compliance needs of bespoke mandates, and to apply their personal views within limits. Individual portfolio managers typically run 20-25 portfolios with varying degrees and sorts of tracking error. Individual portfolio managers cannot deviate from the house risk on/risk off stance but can deviate from the CAT views on asset classes and geographies, within limits.
There can for instance be differences of opinion over equity weightings: “One portfolio manager might be inclined to reduce an overweight equities position, even if the head of global macro remains positive on it. The CAT will weigh up considerations such as strong earnings numbers and balance these against behavioural variables, such as heavy long positioning,” says Barral.
Individual portfolio managers are monitored closely. “Attribution of their positive and negative alpha identifies where the outperformance or underperformance is coming from. It could be factor exposures, such as minimum variance equity lagging in 2020. Or it could be the ESG bias, which outperformed greatly in 2020 but has somewhat lagged in the first half of 2021, partly due to it having some overlap with a growth bias. Deviations are reviewed and portfolio managers are called to account for their leeway on a monthly basis,” explains Beaumont.
The two core model portfolios are diversified beta, which is fairly benchmark constrained, and accounts for around 70% of assets, while flexible absolute return, which has more freedom, makes up the other 30%. “Diversified beta might aim to outperform a benchmark by 50 basis points while flexible absolute return aims for considerably more and beat its benchmark by 160 to 170 basis points in 2020. The Sharpe ratio is an outcome or output rather than the focus, but in broad terms realistic Sharpe ratio targets through a full cycle could be between 0.7 and 1.5 across all mandates. Within this it might be 0.7 to 1 in diversified beta, and 1 to 1.5 in flexible alpha,” explains Barral.
Looking forward, Natixis feel that higher interest rates would be good for all active managers, since they have been underweight of negative yielding bonds.
Pierre Barral, Head of Flexible and Absolute Return, and Head of Multi-Asset Portfolio Management (MAPM), Natixis
Strategic asset allocation, tactical asset allocation and manager selection are all intended to drive outperformance. Key asset allocation views over the past 18 months have included a long-standing underweight bond duration stance, which hurt returns in the first half of 2020, but helped returns later in 2020 and in the first half of 2021.
In equity markets, some shorter-term tactical views have been expressed. Factor exposures have been tilted to be overweight of growth in early 2020 and then shifted to value by late 2020. Somewhat overlapping with this was a geographic move from US to European exposure.
A third level of alpha generation can come from manager selection. “For instance, the selection of Loomis Sayles as an equity manager added alpha over and above the tactical call on growth and outperformed a generic growth index. Similarly in value investing the selection of Harris Associates has contributed to outperformance. Of course, manager selection sometimes also results in negative alpha,” says Beaumont.
The past eighteen months have been generally constructive for the process. “A good climate for the strategy is often when there are strong trends and visibility, which has been seen since May 2020 with clear Central Bank support. In this climate, we might want to take as much risk as possible within mandates. A worse scenario for the strategy could be when markets are disrupted and there are deep drawdowns, such as in March 2020. Then behavioural finance comes into play, in that managers need to make a conscious effort not to reduce exposure in a big drawdown. Looking forward, Natixis feel that higher interest rates would be good for all active managers, since they have been underweight of negative yielding bonds,” says Barral.
The macro process feeds into a distinctive risk parity strategy, which combines quantitative and discretionary elements. “It is based on a structured quantitative approach that determines model portfolios each month based on volatility over the past eighteen months, but there is also some discretionary freedom to adapt tactical views to market conditions and the fund managers’ personal views,” says Pierre Radot, who belongs to the CAT committee and manages NCRP.
The word ‘conservative’ in the fund’s name is sincere. It is highly unusual in employing no leverage; many risk parity approaches will heavily leverage bond allocations to reach the same volatility contribution as equities. Some risk parity approaches will also have a hard wired 60% equity weight which would be much too high for the NCRP risk target. “The strategy is relatively conservative because it is mainly designed as a yield and bond substitute for the French market for general life insurance products. It has an SRRI (synthetic risk and reward indicator) risk weighting of three. Natixis also runs bespoke risk parity strategies with even more conservative mandates, some of which are predominantly invested in inflation linked bonds,” explains Radot.
Seven out of 23 affiliates and 15 funds feature in the ESG range as of May 2021
NCRP is also distinguished from many risk parity approaches in spanning more asset classes – it invests in commodities, and can express views on foreign exchange, mainly using equities (the bond bucket will usually hedge currency risk).
The strategy has its own benchmark model portfolio created monthly by the engineering team. As with the other multi-asset strategies, there are targets for asset classes but also some flexibility to take tactical and personal positions within constraints. The forecast tracking error versus the model portfolio is 2.5%.
“For instance, in May 2021 the risk parity model portfolio had about 10% in equity, but the fund held an overweight stance of about 16%. Within the equity exposure, it was overweight of European and value equities, US and Japanese equities, while being neutral of emerging markets equities overall. Within emerging market equities one idea from the tactical allocation team – overweighting Korean equities, was selected,” says Radot.
“In global government bonds, the fund was underweight of modified duration in line with the house view, but has gone further. The model portfolio sets duration at 6 years, but the fund has gone down to 3.5 years, with its main underweight being in German bonds; partially offset by positioning on peripheral bonds. The universe of sovereign paper is large so that portfolio managers could even express their own views on a market such as Canadian government bonds,” says Radot. But it will not avoid bonds altogether. “We cannot avoid some adverse impact from rising interest rates in 2021, given the tracking error constraints would make it hard to reduce duration to zero or negative, however we can use specific geographic or curve positioning to better cope with a negative environment. And from a portfolio diversification perspective, there is some reason to hold bonds as a hedge against negative or unpredictable events,” he points out.
“We are also overweight of commodities and specifically gold, which reflects our view on monetary policy,” Radot adds.
ESG is not yet applied to all multi-asset class mandates, it is for clients to choose, but there are three multi-manager products on offer. “Natixis’ ESG fund of funds UCITS offering launched in June 2020 provides a menu of three risk levels: conservative funds are 20% equity and 80% bonds; moderate funds are 50% of each, while dynamic funds are 80% equities and 20% bonds. The building blocks for these products are funds from affiliates,” says lead portfolio manager, Nicolas Bozetto, who has spent over thirteen years running ESG mandates.
The aim is to own a mix of funds classified as 9 (“dark green”) and 8 (“light green”) under the European Union’s evolving SFDR (Sustainable Finance Disclosure Regime). The split varies with the three fund of fund mandates: “Currently there is a larger choice of SFDR category 9 funds in equities, and corporate debt, where managers can invest in bonds based on green and social transition. Therefore, our dynamic strategy has about 50% exposure to SFDR 9 funds, including those from affiliate Mirova, which has been a leader in sustainable investing for some years. Other SFDR category 9 funds are some strategies run by DNCA and a firm called Thematics Asset Management, that has strategies focused on water, robotics and safety,” says Bozetto.
The rest is in SFDR 8 funds, which make up a higher weighting in the conservative and moderate risk strategies: “It is currently much more difficult to find SFDR 9 strategies in sovereign debt strategies, and therefore the SFDR 9 weighting is currently much lower for the conservative strategy. The biggest gaps in coverage are seen in this strategy, but this is likely to create opportunities to roll out innovative products,” says Bozetto.
The menu of sustainable funds is expanding every month, as a growing number of affiliates are launching ESG and sustainable strategies, and SFDR should accelerate this: “SFDR is more transparent for clients and we have great expectations for a huge explosion of products,” says Bozetto.
European managers have been the first movers, but there are more US and Asian strategies becoming available. For instance, DNCA Global New World Fund is mostly invested in US equities. Some other US managers have not yet developed SDFR 8 or 9 strategies.
As of May 2021, seven out of 23 affiliates and 15 funds feature in the ESG range, and this has provided strong diversification that has been able to handle every market configuration.
The tally of affiliates offering ESG strategies is very much a moving target that is likely to grow fast. Three years ago, only one manager, Mirova, was offering a sustainable strategy. Now a growing number of affiliates are signing up to UNPRI.
In addition to UNPRI membership or regulatory classifications of funds’ ESG credentials, Natixis has developed its own ESG appraisal called “conviction and narrative” which is necessary, but not sufficient, to garner an investment from the multi manager range. “Some funds that have passed the ESG test might not fit into the current tactical views, which have, for instance, overweighted growth style managers in 2020 and then reduced exposure to them in early 2021,” Bozetto explains.
Though there are two layers of fees, the overall expense ratio is competitive because Natixis obtains discounted fees from its affiliates based on the aggregate Natixis allocation, which tends to mean it accesses the lowest fee institutional share class. “In principle, clients investing in the multi-manager vehicles should not pay any more fees than if they went direct to the underlying managers,” says Bozetto.