Nordea: "Making macro calls doesn't work"

fter years of a largely benign environment, heightened volatility has re-emerged in markets over the past 12 months. Investors in DGFs are now starting to take notice.

Thomas Nehring

Most DGFs broadly have similar aims – equity-like returns with lower volatility, and medium to long-term capital preservation. This is typically achieved by broad asset class diversification.

However, with consistent returns and minimal volatility in recent years, the philosophies and processes powering many DGFs were not stress tested. But this all changed a year ago. The wake-up call was the summer of 2015, as many funds faced stress on the Grexit fears and China hard landing scares. This has continued to occur. Similarly poor capital preservation was on display in January this year, while the volatility on Brexit also caught many managers out.

The Morningstar EAA OE Moderate Allocation sector (EUR) on average fell 4% over one year to 1 July 2016, with a maximum drawdown of more than 10%. The poor protection can be attributed to two reasons. Firstly, many managers overestimated the potential of diversification. In addition, many still make macro calls, which are extremely difficult to do in volatile conditions, and then allocate to assets to reflect these particular views. We decided 10 years ago to shift from asset class investing – such as top down or directional/ beta investments – to focus on return drivers, or risk premia. This allows our GBP Diversified Return Fund to navigate through periods of dislocation, such as the day after Brexit. Our Fund fell only a few basis points on 24 June, despite the near 1% negative downside contribution from our DM and EM beta drivers. This was cancelled out by a number of positive drivers – like low risk equities, govt. bonds and FX.

If volatility is here to stay, managers must seek truly uncorrelated assets – instead of relying on the notoriously difficult task of repeatedly making accurate macro calls. Efficient diversification is not simply about piling into a number of asset classes, but rather the identification of a select number truly uncorrelated positions able to deliver for investors through all market environments.