NN IP’s Willem van Dommelen and Stan Verhoeven on how investors can look beyond economic uncertainty to target long-term returns
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What is the most urgent dilemma that investors face? Surely it is the need to pursue attractive rates of return while remaining conscious of risk. Portfolios may soon need to withstand end-of-cycle macroeconomic and geopolitical turbulence. In this guide, we look at one potential solution to these contradictory needs. NN Investment Partners Multi Asset Factor Opportunities (MAFO) fund is an absolute return factor fund that strives for capital growth and low correlation to traditional asset classes in investor portfolios. Willem van Dommelen, head of factor investing at NN IP, and Stan Verhoeven, lead portfolio manager in the factor investing team, explain their reasoning and tell the story of MAFO’s performance since 2016 in the face of Brexit worries, US-China trade wars and market volatility.
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Investment is subject to risk, including the possible loss of the money invested. Diversification does not ensure a profit or protect against a loss. Past performance is not a reliable indicator of future results. Currency movements can affect your investment returns. For more detailed information about the NN (L) Multi Asset Factor Opportunities fund, please refer to the prospectus and Key Investor Information Document available at www.nnip.com. This is a communication issued by NN Investment Partners B.V. (the “Company”), a Dutch limited liability company registered as an overseas company (registration number FC032623) and as a branch (registration number BR017698) in the register of companies for England and Wales, with its registered address at 25 Old Broad Street, London EC2N 1HQ. The Company is authorised by the Netherlands Authority for Financial Markets and subject to limited supervision by the Financial Conduct Authority. Details about the extent of our regulation by the Financial Conduct Authority are available from us on request. The research by AF Advisors has been prepared independently without influence of NN Investment Partners. NN Investment Partners cannot be held liable for the accuracy, correctness or completeness of the content thereof. The full report of AF Advisors ‘NN Investment Partners Multi Asset Factor Opportunities, Peer Group Analysis, June 2019’ can be downloaded from the website mafo.nnip.com.
Important Information
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For the next couple of years, uncertainty is king. Investors are worrying about the end of the economic cycle and quantitative easing, a possible bear market in equities, and geopolitical events such as Brexit and the US-China trade war. But will fretting about headlines help them earn decent long-term returns? NN Investment Partners’ Stan Verhoeven thinks not. He argues investors distracted by short-term events should refocus on long-term return targets by building more diversified portfolios.
market outlook
Looking beyond uncertainty
Stan Verhoeven, lead portfolio manager, factor investing team, NN Investment Partners
Inflation outlook
Source: FactSet
Alasdair Ross, Lead Manager - Threadneedle (Lux) Global Corporate Bond Fund Alasdair is Head of Investment Grade Credit, EMEA. Alasdair is lead portfolio manager across various global, euro and sterling corporate credit portfolios including Threadneedle (Lux) Global Corporate Bond Fund, Threadneedle European Corporate Bond Fund, Threadneedle UK Corporate Bond Fund, and is also co-manager on the Threadneedle Credit Opportunities Fund. Between joining the company in 2003 and becoming a portfolio manager in 2007, he was a credit analyst responsible for covering the TMT, utility and energy sectors, as well as the sterling whole business securitisation sector. Prior to joining the company, Alasdair worked at BP plc in a rotation of commercial roles. Alasdair has a first-class honours degree in Politics, Philosophy and Economics from the University of Oxford. He also holds the Chartered Financial Analyst designation.
In March a portion of the yield curve inverted for the first time since July 2007 – and some investors are twitchy. Led by US treasuries, short-term government debt around the world has been offering higher returns than long-term bonds, a trend widely seen as the most reliable sign of oncoming recession. Consensus is hard to find, however. A particularly decisive flattening in the US market in March led Morgan Stanley to issue a warning to its clients. In the opposing camp, JPMorgan Chase’s Jamie Dimon struck a more upbeat note. He believes the yield curve’s value as an indicator has been muddied by the actions of central banks and regulators.
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Building blocks
Source: (1) See C.R. Harvey, Y. Liu, H. Shu 2015, and the Cross-Section of Expected Returns, Review of Financial Studies: 5-68. (2) See the correlation of MAFO with equity and fixed income illustrated on p.11 of this guide
Diversification in any portfolio is most critical in uncertain times. But investors need to focus on the effect any additional investment has on their existing portfolio, rather than simply making sure that any new fund they add is diversified in itself. Traditional investor portfolios are often already biased towards long equity and fixed income. Multi-asset funds shouldn’t add to those concentrations. Instead, Verhoeven argues that multi-asset funds should be portfolio “building blocks” that target attractive absolute returns, on the one hand, and diversification in relation to traditional investments, on the other. “So we make sure our Multi Asset Factor Opportunities (MAFO) fund has no long bias towards equities”, he says, or indeed towards fixed income or any other asset class.
MAFO trades a breadth of assets including commodities – an asset class outside the stamping ground of most traditional multi-asset funds. The nice thing about commodities, says Verhoeven, is that while equity markets are dominated by speculators, commodities markets attract additional participants such as producers managing risk and end consumers. In effect, MAFO, through investing, provides services such as market liquidity, to these participants and receives a return compensation for facilitating this. MAFO doubles up on diversification by applying multiple factor strategies across the various asset markets based on value, momentum, carry, flow and volatility. Factor strategies often have low correlations to traditional investments and low correlations to each other. “If you have one strategy with a Sharpe of 0.25, that may not sound amazing, but if you can create 16 of those with zero pairwise correlations your portfolio would have a Sharpe of 1,” says Verhoeven. Of course, MAFO can feel short-term pain from market ups and downs, with Verhoeven citing energy market volatility in November 2018 as a recent example. But over the longer term, he says, its returns should not be dominated by specific market or geopolitical events. Other segments of the alternatives industry such as hedge funds do access the same markets as MAFO but lack its transparency. “Our strategies are the opposite of a black box: we show a lot of detail about what we are doing and why, which a typical hedge fund will never do”, Verhoeven says. The goal is that investors can place MAFO in their portfolios and understand what might happen.
Doubling up diversification
If diversification helps preserve returns, what generates them in the first place? “The factors we employ have three distinct drivers of return: reward for risks other investors are not willing to bear; behavioural biases of investors; and market structure such as in the commodity markets,” Verhoeven says. Behavioural biases include the behaviours that drive market momentum effects, and investor over-reaction leading to under- or over-valuation of assets. Investing in factors has become common practice over the last decade, says Verhoeven, with hundreds of factors now identified by ambitious academics mining large amounts of historical data. But many members of this “factor zoo”(1) are spurious or tricky to implement because of real-world issues such as transaction costs. Success depends on identifying the most robust strategies and executing efficiently. Verhoeven’s team always starts with “a clear economic rationale and defines the expected results. Then we check that the data holds up to those expectations.” That minimises the danger of chasing factors that won’t last the course. It’s one reason the fund has made above-target returns over the three years since launch in 2016, despite Brexit and other turbulence. For Verhoeven, the real success is that MAFO achieved this while demonstrating low correlation with equity markets.(2) Uncertain times, he argues, are precisely when successful investors should turn off their newsfeed and focus on engineering portfolios to make long-term returns.
Risk rewards
The factors we employ have three distinct drivers of return
Stan Verhoeven From 2007 to 2011, Stan worked at Kempen & Co as a quantitative analyst and (exotic) derivatives trader. He joined RBS in London in 2011 and moved to PGGM in 2012, where he was responsible for research into alternative risk premia. In 2015, he joined the Factor Investing team at NN Investment Partners, where he develops and manages a broad range of rule-based strategies, in addition to being Lead Portfolio Manager of MAFO. He is a CFA charterholder and holds an MSc in Business Administration from Radboud University, Nijmegen.
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NN Investment Partners Multi Asset Factor Opportunities
fund snapshot
Gross returns over relevant risk free rate of NN (L) Multi Asset Factor Opportunities versus direct peers (1)
fund launch
Risk target/budget
Base currency
23 March 2016
10% long-term volatility
USD
Source: Columbia Threadneedle Investments at 31 March 2019.
Source: (1) Morningstar Direct (3 year, May 2019) via AF Advisors. (2) AF Advisors, NN Investment Partners Multi Asset Factor Opportunities, Peer Group Analysis, June 2019
Ahead of the curve: reading the runes on risk
Value, momentum, Carry, flow, & volatility
5 factors
equity, fixed income, currencies & commodities
4 asset classes
return objective
1 month US Libor + 6% (Gross)
NN (L) Multi Asset Factor Opportunities
“All peers realised cumulative three-year returns between 0% and 10%, whereas the NN IP strategy is the only factor-based strategy that yielded substantial returns even given its relatively high volatility.” AF Advisors (2)
NN IP Multi Asset Factor Opportunities
Source: (1) AF Advisors calculations based on Morningstar Direct data (3 year, May 2019). (2) AF Advisors, NN Investment Partners Multi Asset Factor Opportunities, Peer Group Analysis, June 2019
Source: (1) NN IP Factor Investing team. As at 30 April 2019. (2) NN IP, Bloomberg. Data from April 30, 2016 – April 30, 2019 and quoted in USD. Equities is MSCI World Net Total Return (NDDUWI) and Fixed Income is the Bloomberg Barclays Global Agg. Government Total Return Index (LGAGTRUU). MAFO refers to NN (L) Multi Asset Factor Opportunities I-share USD (gross of 0.81 bps annualized ongoing charges). The indices mentioned here are presented for the purpose of comparing with equities and fixed income, and should not be considered benchmarks.
“In summary, NN IP’s relatively lean and mean approach towards alternative risk premia investing enables it to charge lower fees versus its peers, but at the same time it is achieving attractive returns against an acceptable risk. As such, NN IP may be considered an attractive alternative within this segment.” AF Advisors (2)
Correlations of NN (L) Multi Asset Factor Opportunities and direct peers vs equity and fixed income benchmarks (1)
NN (L) Multi Asset Factor Opportunities: Key statistics (2)
Factor performance (1)
Fund size (mid-basis)
Investment philosophy
MAFO is designed to deliver a target absolute return of 6% on top of 1-month US LIBOR over a 12-month period while delivering diversification benefits. The strategy is designed to fulfil investors’ needs to create more stable portfolios while adding a true diversifier to traditional asset classes as well as to other liquid alternatives. It achieves the target absolute return by systematically applying five so-called investment “factors” – value, carry, momentum, flow, volatility – that have a long standing in both academia and investment practice. The fund invests in the factors using equity indices, treasury futures, currencies and the 23 commodities on the Bloomberg commodity index. The approach means MAFO offers both an absolute return target and significant diversification benefits.
What exactly is MAFO designed to do for investors?
We differentiate ourselves by keeping things simple
We have done well. Over the first three years of the fund, MAFO generated an annualised return of 8.98%, thereby outperforming 1-month US Libor + 6% annualised. That’s in a period including the withdrawal of quantitative easing, the Brexit referendum, and last December’s stock market volatility.
You’ve just passed your three-year launch anniversary, how have you performed?
Well, if you look at October and December 2018, equity markets went down by more than 7% and our fund, if you sum up the performance in October and December, was actually up. But we lost out in November on the back of a spike in natural gas prices early in the month and later a huge drop in energy prices. So in Q4 overall we went down, like a lot of funds, but actually not in the same months as equity funds. That’s the big message: we’ve outperformed our target over the full three years while demonstrating low correlation with equities.
Any nasty surprises along the way?
Not exactly. We differentiate ourselves by keeping things simple. There is ample evidence that many bells and whistles added on to ‘traditional’ factors do not add any value, and even worse that they destroy value and are just the result of data mining. Our focus on simplicity enables us to understand the sources of return (factors) that we harvest and what risks they entail. Our approach is built on a robust research process whereby we regularly re-evaluate our strategies to ensure we are not dogmatic.
Not every factor strategy has delivered the results investors wanted. How do you differentiate yourselves, through inventing new approaches?
The individual factors we apply have proven their worth in practice over the longer term and are here to stay. As mentioned earlier, they pick up different sources of returns and hence are uncorrelated to each other (and to traditional investments). So what drives the ability to target absolute return is the positive expected return of factors over the long term and their low pair-wise correlations. In case factor A does not perform in period X then, since factors are relatively uncorrelated and have long-term positive expected returns, it is likely that factors B and C will perform - so on a net basis there is an absolute return.
So what drives that ability to target an absolute return, beyond diversification benefits?
Willem van Dommelen, head of factor investing at NN Investment Partners
Dedicated factor investing team MAFO is managed by NN Investment Partners’ factor investing team. The seven-strong team of portfolio managers combines quantitative research and portfolio management, working closely with NN IP’s trading team and the centralised innovation and data team. MAFO’s lead portfolio managers are Willem van Dommelen, head of factor investing at NN IP, and Stan Verhoeven, lead portfolio manager in the factor investing team.
Alasdair Ross, Lead Manager - Threadneedle (Lux) Global Corporate Bond Fund
So is factor investing passive or active? – van Dommelen’s view
MAFO is built on active research to find, assess and review the factors used in the model. We implement the model on a daily basis to optimise its performance. The real point is that factor investing must be systematic: the strategy should deliver the exact same thing in the future as in the past, given the same market environment. Markets never stay the same, of course, but the contrast with traditional discretionary managers is clear: they can change their opinion and react quite differently to similar markets.
There are three key steps to imposing discipline. Every factor strategy we include in our portfolio must have a clear and strong economic rationale and academic underpinning; must have proven itself over the long run, in and out of sample and across asset classes; and must offer attractive returns taking into account implementation costs. You do have to build a rigorous research process – and you do have to stick to it!
Is a disciplined approach easy to build given that the growing number of factor approaches include some that seem spurious or that side-step real-world issues, e.g., implementation costs?
Research process
Willem van Dommelen After graduating with an MSc in Business Economics from Tilburg University in 2002, Willem joined ING Investment Management as a portfolio manager. In 2004, he became Senior Portfolio Manager in Structured Investment Strategies. Willem became Head of Factor Investing in 2009, in which role he is responsible for the development and management of a broad range of factor-based strategies and investment solutions at ING IM, which was rebranded as NN Investment Partners in 2015.
Idea generation
Data collection
Testing base model
Periodic review
Implementation
In-depth research
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Investment process
Fully systematic process
Efficient implementation and execution
Detailed risk monitoring and reporting
