The Billion Dollar Interview with Hans-Olov Bornemann, Head of Global Quant Team at SEB Asset Selection Fund
Skandinaviska Enskilda Banken AB (publ) (SEB) has over 150 years of experience as a leading financial institution in the Nordic region. The group is present in 20 different countries, employing approximately 16,000 individuals. The bank serves 2,800 large corporates and institutions, 400,000 small-and medium-sized companies and 4 million private customers. In the Nordic countries, SEB has a particularly strong position in Asset Management, Merchant Banking and Private Banking.
SEB Asset Management has a multi-boutique structure with strong investment capabilities across all asset classes offering solutions to institutional investors, retail and private banking clients. It counts approximately 570 employees including more than 100 investment professionals in 20 investment teams across Scandinavia and the Baltics. Today, SEB is one of the leading asset managers in Northern Europe with more than EUR150 billion in AUM (as of 31 March 2013).
SEB Asset Selection acts within the tactical asset allocation space. The team tries to generate positive returns by actively taking long and short positions in four different asset classes - equities, fixed income, currencies and commodities. The Global Quant Team manages in total some EUR 850 million (per end of April 2013) in the SEB Asset Selection ‘family of funds’ (with different volatility targets).
Eurekahedge: Keeping in mind the current market scenario of rallying markets globally, how has your fund captured the gains on offer over the last two quarters?
Our quantitative model has been particularly successful in the last four to five months in identifying the bullish trend in the world equity markets as well as the remarkable moves in the currency markets, e.g. the weakening of the JPY and the strengthening of the Mexican peso.
EH: Your fund delivered excellent returns of nearly 25% in 2008 – how was your fund positioned at the time and what was your most profitable theme during the year?
Our fund prefers markets which show longer lasting positive or negative trends. The year of 2008 was great for our strategy, because all asset classes showed clear trends: government bonds and the US dollar were in strong upward trends and equities and commodities were in clear downward trends. We made money everywhere that year.
EH: Since 2008 the performance of your fund has been less than spectacular – with slightly negative returns in 2009 and 2012. Does your returns profile imply a contrarian strategy or have you adjusted your strategy in the wake of the financial crisis?
The combination of clueless, nervous market participants and recurring interventions by politicians and central bankers resulted in a risk-on, risk-off behavior that some commentators referred to as ‘the new normal’. In the last quarters, however, it seems that the market behavior has come back to ‘the old normal’ again. Investors have finally formed a pretty clear medium to longer term macro scenario. Political and/or economic events, which one to two years ago would have caused them to change their view by 180 degrees from one day to another, is today only causing them to fine-tune their scenario. The more confident forecasting is creating more extended market trends and funds such as ours, which try to capture the most typical market behaviors, start to deliver good returns again. If you want to put SEB Asset Selection into a box, the medium term trend-following box would probably be the most accurate one.
EH: How do you use quantitative models to develop investment themes? Tell us about your quantitative models. How much is the human input in taking the investment decision?
We tend to say that we are 99% systematic and 1% discretionary in our approach. Since inception in 2006, we have only intervened once with the model (in December 2008 when we reduced the overall risk by 50% for a short while). Academic studies have shown that humans on average are pretty poor at making investment decisions. They buy securities that have already gone up for a while and they sell securities which have already gone down for a while. The basic idea of going with the trend is not too bad, but the problem is that they tend to join the parties when the music has already stopped playing. They are also famous for being the last ones to leave sinking ships, hoping that the ship miraculously will get back to the surface again. The end-result is that they buy high and sell low, an unwise strategy. Admitting that we are all humans in my team and that we probably suffer from the same human deficiencies, we refrain from making those emotional investment decisions and instead let our quantitative model calculate the probabilities for markets going up and/or down and take the appropriate positions on that basis. We are very happy with the results that this approach has delivered.
EH: How do you determine asset allocation across different asset classes – is that also done systematically? What is the average holding period of your investments?
All asset allocation decisions are pursued in a systematic way. The default position in our portfolio is the risk free rate of return, i.e. we tend to have a base portfolio consisting of holdings in high quality government bills. The base portfolio is always there. When it comes to all other kinds of asset allocation decisions, we follow the principle of only taking on active risk, if and when we have the odds on our side. Thus, there is no obligation for us to carry risk at any specific point in time. Our model tends to identify pretty interesting asset allocation opportunities on a fairly frequent basis. We forecast returns, volatilities and correlations daily. With all this data at hand, we take new positions that start to look promising, we scale up or down existing positions depending on their level of attractiveness and we exit positions that have lost their attractiveness. All in all, we turn over about 20% of the funds NAV per day in underlying derivative exposure. In other words, we are pretty active an investor. It should also be noted that our model is equally active in trying to preserve the existing capital as it is in capturing new money making opportunities. The average holding period tends to vary within an interval of one to three months.
EH: With the present movements across markets and underlying asset classes, generating attractive absolute returns is a risky business. What are the risk management tools and practices that you have in place to safeguard the portfolio of your investments? How do the UCITS regulations affect the quantitative nature of your fund?
Within the Global Quant Team we have developed a 100% proprietary risk management system. The risk system not only estimates a set of the usual risk parameters like value at risk, volatilities, correlations, event risks, concentration risks, liquidity risks and so on - the risk system has also been fully integrated into our forecasting and position taking model. While our forecasting model has made sure that our fund has been able to beat the NewEdge CTA Index (which comprises the 20 largest CTAs in the world – SEB Asset Selection is one of them) since inception in 2006, our risk management system has ensured that both the overall volatility has been lower and the max drawdown more limited than for our competitors.
When it comes to the UCITS regulations, ESMA in recent years have been making life more and more difficult for fund managers who run the VaR approach and who make use of modern investment techniques. You may have 100% of the fund invested in a highly illiquid basket of almost bankrupt companies and top it up with a 100% derivatives exposure to a roller coaster emerging market equity index, but you are not allowed to have a T-bill and government bond portfolio with more than 100% exposure to a single state like Germany or the USA. How do such rules protect the end investor? Another oddity is that the KIID risk-indicator for traditional funds is based on the historical average volatility, whereas the risk indicator for a VaR-fund shall be based on the fund’s maximum volatility. Since the maximum volatility will come out much higher than the average volatility, investors are fooled to believe that modern funds are substantially more risky than traditional funds. It is quite evident that the decision makers think that losing a lot of money ‘the old way’ is much more acceptable than losing some money with the more modern VaR approach. Unfortunately, they miss the whole point. Modern investment techniques are predominantly used for limiting the downside risk and for preserving the fund investors’ capital. Some decision makers would benefit a lot from studying how well or poorly traditional funds and VaR funds, respectively, performed during e.g. the year of 2008. The VaR funds I know of did a much better job of protecting the downside than traditional funds did that year.
EH: Do you feel that you could offer greater performance to investors by offering a less liquid offshore fund outside of the constraints of the UCITS umbrella? Have you come across investment themes that you wanted to invest in but were restricted from doing so because of the regulations?
As a team, we are not at all attracted by illiquid investments. In 2005, we did a research study of global hedge fund failures. The single most important reason for their failure and the only factor that was present in all cases was the fact that these hedge funds had invested a substantial portion of their money into illiquid securities. When you think about it, it’s pretty obvious that you should be very cautious with illiquid investments: if the hedge fund manager is unable to unwind or at least hedge hurting positions, he is no longer in control. Without the ability to conduct risk management, it is only a question of time before the fund ‘gets killed’. Two years later in August 2007, one of Wall Street’s most successful hedge fund teams had made the same mistake. Over the following four years, their two flagship hedge funds (which at the peak had some US$15 to US$20 billion in AUM) had to be closed down because of incredibly poor performance and the never ending tsunami of redemptions. One should only invest in illiquid assets, if clients are subject to a lock-up of at least three to five years.
When it comes to alpha opportunities that cannot be pursued by a UCITS fund, these opportunities are predominantly found in three areas: commodities, short interest rates and unlisted assets. We would of course have preferred a more flexible UCITS law, but on the other hand, our UCITS-compliant track record shows that this constraint can be more than offset by better forecasting and better risk management. There are plenty of interesting alpha opportunities in UCITS eligible assets.
EH: What kind of investors is your fund targeted at? Can you provide a broad breakdown of your current investor base by type and geography? (e.g. 40% institutions, 40% HNW investors, 20% retail investors)?
Because of SEB’s powerful distribution capabilities to HNW - and retail investors, we still have a tilt towards private individuals. Roughly one third of assets derive from institutions and two thirds from HNW and Retail.
EH: What do you think will be the outcome of the European debt situation? Do you think other struggling European countries will take ‘depository tax’ actions similar to Cyprus?
It is a positive development that market forces are coming into play again. Although the principles of market economy may be very painful over shorter periods, they tend to cure the problems in the fastest and best way. Governments should focus on constructing rules that minimise/eliminate dependencies between banks, that minimise conflict of interest, that re-establish a more reasonable level of banks’ willingness to lend money to private individuals, that make sure that corporations do not take undue advantage of their clients, that maximise efficiency in the public sector and, last but most importantly, that make sure that governments are prohibited from running budget deficits and borrowing money without triggering immediate and correspondingly large cost cuts and/or tax increases. The single most important reason for the current economic crises is the complete lack of governance of governments. Instead of acting in the long term interest of the nation, the current governance body, the voters, have happily been stealing consumption from their children and grand-children for three decades now. The corporate sector (excluding a number of poorly run banks), has had a reasonably well functioning governance body for some time, i.e. via their board of directors. The corporate sector is – in spite of the crises - in a very good shape today. Governments and private individuals who both lack appropriate governance, have ended up in major trouble. The former, because the governance body of governments was populated by consumption-addicts who lack a macro economic understanding. The latter because the consumption-addicts were allowed to borrow any amount of money from the banks to fulfill their desire for immediate consumption. In addition, central banks and their boards – probably unknowingly – also supported the consumption-addicts by lowering the general interest level. Thus, consumption-addicts have been flying really high for three decades now. But reality always catches up. We are now in the clean-up phase and all decisions tend to focus on two questions: a) ‘Who should we force to pay the bill for the three decade consumption party?’ and b) ‘Over what period shall the bill be paid?’
EH: What is your near and medium term outlook of the markets, and different asset classes that you invest in? Are there any particularly exciting investment themes that you would like to share?
Our model indicates that there are currently plenty of opportunities available in the currency markets. Thus, we carry larger and more numerous positions in the currency market today than we normally tend to do. The dramatic development of the Japanese yen and the lack of international criticism indicate that governments around the world are embracing market forces in the foreign exchange markets as well. Historically, periods dominated by market forces – as opposed to extreme government involvement and dramatic central bank interventions – have generated good returns for managed futures funds. We, of course, keep our fingers crossed that the trending markets of the last four to five months will continue for years to come. If so, history would just repeat itself as it tends to do.
N.B. The views expressed above are the interviewee’s personal views, which may or may not be consistent with the views of his employer.