Mizuho Alternative Investments (MAI) is an investment advisor dedicated to developing and managing quantitative investment strategies. MAI was established in April 2007 as a subsidiary of the Mizuho Financial Group, one of the largest full service financial institutions in the world with total assets of approximately US$1.7 trillion (as of 12/31/2016) and a global footprint. MAI is located in New York and manages or advises on approximately US$3.7 billion1 in assets, primarily for institutional clients (as of 3/31/2017). Investment products managed by MAI include CTA and quantitative global macro strategies and risk premia solutions.
- Please share with our readers a bit of history about Mizuho Alternative Investments (MAI) and the background of the key members of your team.
Our team consists of 29 professionals. We have a Management Committee that is comprised of five senior professionals with management responsibilities in key functional areas of the business. Most of us have extensive experience in the alternatives industry.
The investment team is led by Mr. Kazuhiro Shimbo, MAI’s Chief Investment Officer. He is responsible for overseeing all aspects of the MAI’s quantitative investment programs including the research process, portfolio management, execution and investment risk management. Mr. Shimbo joined MAI at its inception. Prior to that, he was with the Industrial Bank of Japan (IBJ) serving as a Quantitative Researcher and a Portfolio Manager at the bank’s derivatives market making desk. Mr. Shimbo has a Ph.D. in Applied Probability from the School of Operations Research and Information Engineering at Cornell University. He also holds an M.Sc. in Financial Economics from the University of London and a B.S. in Physics from Kyoto University in Japan.
Mr. Henry Tang serves as MAI’s Director of Research. He has over 18 years of experience in the alternative investments industry. Before MAI, Mr. Tang spent 13 years at Goldman Sachs Asset Management where he was Senior Portfolio Manager for the firm’s Global Alpha Fund, leading the research and development of trading strategies in Fixed Income, Currencies, GTAA and other macro investment strategies. He holds B.S. and M.Eng. degrees in Computer Science and Electrical Engineering from Massachusetts Institute of Technology (MIT).
- We understand that Mizuho Alternative Investments and Wilshire Associates have partnered to implement solutions in the risk premia space. Could you tell us more about this initiative and the combined capabilities that both firms bring on this front?
MAI has been quite active in the field of risk premia and this remains a key focus area for our team. We made the decision to enter the risk premia space in response to a rapidly growing institutional demand for liquid, systematic factor-based strategies that can be used as portfolio building blocks.
Approximately three years ago, we partnered with Wilshire Funds Management (WFM or Wilshire), an asset management unit of Wilshire Associates, to source, due diligence and implement quantitative risk premia portfolios. Our objective is to provide investors knowledge, advice, tools and access needed to benefit from the offerings of the risk premia strategies in the marketplace. We create outcome oriented portfolios of risk premia strategies and customised solutions for investors to address a specific portfolio need. The team has developed a comprehensive database and process to evaluate hundreds of strategies from investment bank providers. Our current products include a broadly diversified risk premia portfolio, an income oriented portfolio, a tactical overlay and a defensive portfolio.
Our collaboration with Wilshire is structured to leverage the two firms’ complementary skill sets. Both firms have long standing investment expertise and MAI brings to the table its quantitative investment process and experience. In addition, Wilshire’s operational platform has played an important role in allowing us to deliver to investors a turn-key solution where required.
- Let’s go into a bit more detail. What is risk premia based investing and how different is it from smart-beta investing? What is the opportunity here for investors, especially in relation to fees and the underlying liquidity and transparency pertaining to their investment?
Investors have typically categorised their investment returns in two buckets — beta, benchmark-like exposure to financial assets, and alpha, the active outperformance of an investment relative to a specific benchmark. When decomposing the alpha part of a portfolio, many investors now believe a percentage of those returns can be explained by certain factors. So, what was previously thought of as outperformance or manager skill now can be described to include smart beta and risk premia, which have certain differences.
Smart beta strategies are quantitative equity-based strategies that rely on ideas that are academically proven and often adopted by long-only active equity managers. They are long-only by nature and their selection and weighting schemes usually are based on objective factors such as value, risk, quality, etc. of the individual companies in the universe.
Risk premia strategies can be viewed as an extension of the notion of smart beta, but there are two key differences. First, risk premia strategies include both quant macro strategies, applied across asset classes, as well as quant equity strategies focusing on a bottom-up approach. Second, risk premia strategies are typically designed to maintain low correlation to traditional assets, such as equity or fixed income, due to their long/short or market neutral nature. Risk premia investing is premised on factors that are prevalent in hedge fund strategies, with focus on styles that are uncorrelated to traditional, long only assets.
In a world of low interest rates and low volatility, with the hedge fund performance lagging, investors are increasingly focused on fees. Accessing alternative beta through systematic risk-premia strategies can be more cost-efficient than investing in traditional actively managed hedge fund strategies. Furthermore, because of the rules-based and transparent nature of the strategies, investors have greater control over the specific exposures and risks they take.
The concept of risk premiums is based on well-understood, broad and persistent sources of risk and return that are usually documented in academic literature. Examples include strategies based on value, momentum and carry. When constructing risk premia portfolios, we generally start with a particular investment objective. Examples include gaining exposure to certain asset classes or strategies or selecting strategies that play a particular role in a portfolio (e.g., defensive strategies designed to outperform when market volatility increases). Portfolios can be designed to access a diverse set of risk premiums, which tend to be uncorrelated, allowing investors to achieve more stable risk and correlation benefits. Similarly, the strategies can be used to construct an overlay or a hedge to an existing asset allocation framework.
What are the core and non-core risk premia strategies on offer and which asset classes do they cover? What is the rationale behind classifying credit and rates as distinct asset classes and could you share with our readers why certain styles/factors are not offered for certain asset classes (e.g. value strategy across credit)?
The graphic below details the core strategy styles and asset classes covered by risk premia strategies as we see it. We break out equity factor to cover strategies comprised of individual equities versus strategies based on equity indices. Examples of non-core strategies could be hedge fund ‘replication’ or other rules-based applications of popular hedge fund strategies (merger arbitrage or strategies based on 13F filings, etc.). Credit and rate strategies are classified separately to reflect certain spread relationships and other factors associated with high yield instruments. Because risk premia strategies are generally thought of as being based on known factors or academic research, certain styles do not necessarily apply to all asset classes (e.g. value strategies on credit). In the credit space in particular, there are certain limitations and constraints arising from liquidity and transparency of the underlying assets that make it difficult for the risk premia format.
- Please walk us through the different channels via which investors can get access to your risk-premia based solutions.
As explained previously, we provide investment expertise and flexible structure to help investors access risk premia strategies. In this space, effective implementation of known and tested strategies is very important. Our business model provides access to strategies from multiple bank providers (vs. single provider solution) and is provider agnostic. We look across a complex array of offerings and their inter-dynamics to select the risk premia strategies that meet investor needs.
Some of the ways in which we work with clients include:
- Fund products - Commingled funds consisting of risk premia strategies managed by MAI/Wilshire.
- Discretionary customised solutions - Turnkey, full service solution. MAI/Wilshire source, due diligence, construct, implement and monitor risk premia portfolios. This can be implemented on a fund platform operated by Wilshire or a third party platform.
- Advisory relationships – Investor retains decision making power. MAI/Wilshire advise clients on due diligence, portfolio construction and/or operational implementation of risk premia strategies.
- Focused advisory solutions – MAI/Wilshire work with the investor on any one specific or multiple aspects of the investment and/or operational process associated with risk premia investing.
- For risk premia solutions offered in a fund structure, can you walk us through the process from strategy sourcing, due diligence to portfolio construction and management? Could you share an example of one such fund with our readers? How far back does the live track record go?
Our investment process is robust and tailored to take advantage of complementary skill sets of MAI and Wilshire. The key steps of the process include:
- Strategy Sourcing: Our database serves as the central depository for industry-wide information on risk premia offerings by major banks. The data is classified to allow customised searches and groupings based on key criteria.
- Strategy Due Diligence: Building blocks are analysed individually. Process includes quantitative and qualitative due diligence performed by members of Wilshire’s investment team and MAI’s quantitative experts.
- Validation and Testing: For strategies included in the final portfolio, the process includes a detailed analysis of the underlying algorithm, examining its robustness, cost and sustainability under various market regimes.
- Portfolio Construction: Leveraging our quantitative experience, we employ a proprietary risk budgeting approach to arrive to a desired volatility, correlation and distribution profile for the portfolio.
- Portfolio Management and Monitoring: Each portfolio is managed either actively or passively based on client need. When mandated, we attempt to add value by periodically modifying the composition of the portfolio and weights of the underlying building blocks. Leveraging Wilshire’s risk analytics, we monitor the portfolio and its individual components using position level data that underlies the swaps.
Today, we have several fund offerings in the risk premia space. Our first fund was launched in August 2015 and is comprised solely of risk premia strategies provided by major banks. The portfolio is a low volatility portfolio designed to include strategies that are relatively insensitive to spot prices across asset classes. The fund strives to harvest profits from fundamentally uncorrelated risk factors. It includes income oriented strategies, such as forward curve carry, volatility carry, credit carry as well as cross-asset momentum strategies with the objective of reducing opportunity cost during ‘risk on’ periods.
- With regards to risk-premia strategy sourcing and due-diligence, how are the risk-premia products structured and harvested under a systematic strategy? For an investor, how can they ensure they are exposed only to say trend following (momentum) and not to other sources of risk-premia (mean reversion, carry)?
As with investing in hedge funds, due diligence and ongoing monitoring is of critical importance when investing in bank-sponsored risk-premia strategies. Strategy quality checks are important in understanding each strategy’s expected performance in order to gauge the robustness of design and aid in assessing suitability for investment.
As part of our due diligence process, we perform quantitative clustering analysis to determine the attributes of a particular strategy. We collect qualitative information such as asset class and style from strategy providers. We then perform quantitative analysis to determine if a particular strategy ‘clusters’ with strategies with similar asset class and style designations. We then do performance analysis to benchmark each strategy versus its peers adjusting for volatility and trading costs. This helps to assess whether a strategy may be introducing unintended factor exposures or if it is a pure representation of a certain risk premia.
In addition, it is important to analyse how a strategy performs in terms of its positions, exposures and risk in different market environments. This requires a deeper understanding of the strategy rules. Also important is to analyse a strategy’s correlation characteristics and perform scenario based analysis (such as rate hike, crisis periods, etc.) to ensure that the ex-post behaviour is as expected.
As with any investment, after a strategy or a portfolio is implemented, ongoing risk and investment guideline monitoring is employed to ensure that the strategy is performing as expected. Because most bank-sponsored strategies are transacted as a total return swap on an index, it is important to decompose the index to the underlying position data to perform meaningful risk and return attribution.
- How big is the market for risk-premia based products, and how much are you currently allocating in this space? Is there concentration of counterparty exposure in your exclusive database of bank provided risk-premia swaps or do you see a more even distribution across the major banks?
We believe that the market for bank-sponsored risk-premia strategies currently exceeds US$150 billion in notional as of 31 December 2016, encompasses over 1,000 strategies and is growing rapidly. Based on our estimates, there has been significant growth in notional over the past three years. MAI/Wilshire’s current notional allocation is over US$1 billion. Our database tracks the strategies of ten of the largest bank risk premia providers. Based on our data, there are a handful of large providers and a growing number of newer entrants.
- What is the level of investor interest around risk-premia based solutions and what type of investors (pension funds, family offices, and etcetera) do you currently cater to?
We see increased interest from all types of investors. Initially risk premia investing was popular with Nordic and Australian institutions. Now we see growing interest from institutional investors such as pensions, endowments, foundations, family offices and fund of funds globally. We are also seeing implementation of risk premia strategies into wealth management networks, insurance products and registered funds in the United States designed for retail investors. Our current investor base includes institutional investors, family offices and retail investors.
- On a final note, how does risk-premia based investment fit in an institutional investor’s portfolio, more importantly what does it displace in a portfolio competing amongst traditional, smart-beta and alternative investments? Should hedge fund managers be worried about the growth in risk-premia based investing? What do you foresee for the risk-premia based approach to investing?
Institutional investors’ approach to asset allocation is evolving as certain style factors are increasingly integrated into portfolio construction frameworks. Historically, institutions diversified their investment portfolios across asset classes (stocks, bonds, commodities, alternatives, etc.), but markets have demonstrated that simple asset class based allocation might be suboptimal. As a result, many institutions are now actively making allocations to diversifying or risk-mitigating strategies.There are many different uses for risk premia strategies in institutional investor portfolios. Many investors use risk premia as alternative beta strategies, accessing alternative factors or strategies in a more passive fashion than investing in hedge funds. Some investors are concerned with hedge fund fees and the recent lacklustre performance, so they utilise risk premia as replacements or compliments to their existing alternatives portfolio. Others use them for portfolio completion purposes or to express a portfolio tilt.
Increasingly we see risk premia strategies used as building blocks to achieve a specific portfolio objective or outcome. This could include constructing defensive or risk mitigation portfolios or designing portfolios as an overlay or completion strategy to existing exposures. Given the flexibility of these strategies and that they can be obtained at a lower expense level than hedge funds, we foresee continued growth in risk premia investing.
Global Head of Strategy
Mizuho Alternative Investments
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