IN CONVERSATION

Nerds must leave herd says PanAgora chief

There is room for more innovation in funds management, says chief executive of PanAgora Asset Management, Eric Sorensen, who believes being different is critical to success.Being a quantitative manager comes with a degree of baggage. Overcoming the misnomer “nerds with black boxes” is one obstacle, chief executive of PanAgora Asset Management, Eric Sorensen says, as is communicating the differences within the broad categorisation.

“Defining hedge funds is extremely difficult, probably the best definition is how they charge. Quants have been defined as nerds with black boxes, and that’s not right either, in both cases there is a lot of diversification in the strategies,” Sorensen says.

He acknowledges a defining characteristic of quants compared with other techniques, is that they rank holdings, and the skill is in providing the best ranking structure and building the portfolio. But he also believes there is room for improvement.

“What’s missing might be the appropriate subjectivity, depth of insight, instinct, and not being responsive to change,” he says.

As a general classification, quants underperformed in 2007 and 2009, and for Sorensen this points to a larger problem in asset management in general.

“They were all using the same thinking, the same benchmarks and similar risk models so there were similar positions. Commonality was a problem for quantitative investors and more generally too,” he says.

Having just read Michael Lewis’, The Big Short, Sorensen is further inspired by the need to be different.

“So much money flowed in to these strategies and no one was on the other side, you need to try to be different, it’s critical,” he says. “Funds managers shouldn’t be tinkering with a process, they should be innovating.”

Famous for trademarking the term, and approach, Risk Parity, in 2005 – “Risk Parity Portfolios: Efficient Portfolio Through True Diversification” – PanAgora is research- and innovation-based in its approach.

The Risk Parity approach – which allocates by risk, not capital – is equally applicable to overall strategic asset allocation as it is to an individual asset class, as with the PanAgora Global Equity strategy.

The practice, on a holistic basis, is being closely examined by a number of US pension funds which have been disillusioned by the traditional asset-class asset allocation methodology where equity risk dominates.

Adopting such approach across an entire portfolio will reduce risk, but in the meantime will also reduce return, so leverage is introduced.

“You can’t eat the Sharpe ratio, so you need to leverage, and we overweight bonds by using derivatives. Bonds have a nicely behaved distribution no matter what the time period,” he says.

Sorensen’s colleague, Jesse Huang, director of strategic relations, says the approach has received some critiscim because of the use of leverage.

“There’s a criticism that by leveraging bonds you’re taking on more risk, but that’s a misunderstanding of the approach. It is taking a risk-budgeting approach and saying I have a target return and what’s the least volatile way to achieve that,” Huang says.

Similarly Sorensen says caution is needed: “”You put leverage in front of a greedy trading desk and you have a problem, but it is a very efficient way to run money.”

At the crux of the Risk Parity approach is a belief that cap-weighted indices are not an efficient way to achieve passive exposure to an asset class because they are undiversified with unnecessarily high risk.

“There should be a movement to reconsider what we call a benchmark,” he says. “There is somewhat of a move towards alternatives to it, and a trend away from tracking the cap-weighted index. Managers also have to move to understand what the high-volume trading people are doing, and to understand why a stock has moved for non-traditional fundamental reasons.”

Sorensen, who claims to have first learnt about volatility as a high-performance jet fighter, says PanAgora is labelled as a quant investor but he sees his competition as more with fundamental firms.

“We have built processes for exposure, but we use fundamental data. But gone are the days of looking at P:E and growth rates, look at where revenue coming from and build models around that,” he says.

As an example he says the firm changed its process in 2007 to encompass the credit issues in US banks and the quality to loan measure, so solvency was added as a determinant.

To this point, he believes adaptability needs to be embraced by quants, which he says have suffered from not having a top-down economic view.

“You can’t let the machine tell you every decision, you have to take some risk,” he says.

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