By Hamlin Lovell, NordicInvestor
Nordic Investor interviewed Teemu Ahonen, Head of Absolute Return at Ilmarinen in Helsinki, who manages around EUR 5 billion – approximately 10% of Ilmarinen assets. There is an internal absolute return fund, and external allocations to liquid absolute return strategies including global macro, emerging markets, CTAs, multi-strategy, equity market neutral, and credit relative value. (Other teams at Ilmarinen run illiquid alternatives, such as private equity and real estate).
“People confuse alternatives and absolute return. In bad times they call it alternatives, and in good times they call it absolute return. We just focus on absolute return at all times”, says Ahonen, who spent several years working on Brummer & Partners’ Nektar strategy in Stockholm before returning to Ilmarinen last year. He now oversees a concentrated, high conviction book of external managers, with turnover typically around 10% a year. “We carry out careful due diligence and stick to the strategy mix once we find it, investing in funds rather than managed accounts. We change funds when we get fresh idiosyncratic ideas”.
The Great Coronavirus Crisis (GCC) has not been a reason to change allocations, since the managers have been performing well. Ahonen reckons a more volatile market is better for active management, and is overweighting active versus passive management.
Ilmarinen’s external managers are also mainly discretionary rather than systematic. Core holdings include some well established discretionary global macro managers that have performed well over decades. They have also done particularly well in volatile times such as the first quarter of 2020 – and the climate may be improving for active management of macro: “macro has had a tough ten years with central banks driving markets and investors selling volatility and seeking yield. Now the policy mix is moving from pure monetary policy to coordination between monetary and fiscal policy, more market volatility should allow active managers to make money. It is too early to tell if we have arrived at MMT (Modern Monetary Theory) – and the charters of most central banks have not yet been changed to allow for spending – but markets need to price in more political processes behind decision making”.
After his call on active management, Ahonen’s second most confident prediction is that, “markets are not pricing in enough volatility, with many portfolio and risk sizing tools under-estimating it. Markets could become more unstable when volatility does strike again”.
Macro managers are hotly debating whether deflation or inflation is more likely. Ahonen expects the next two years will be deflationary and that there might eventually be an inflation shock, but he is not too focused on this outlook, partly because the path markets follow can be as or more important than the final outcome. Whether the end game is deflation or inflation is for managers to decide on, and some of them could be investing in gold as an inflation hedge, but Ahonen does not fixate on this in his manager selection.
Ilmarinen has some exposure to systematic strategies and managers, such as CTAs. Though Ahonen recognizes the academic arguments for such allocations, he fears that some systematic strategies can be applying a lot of leverage to risk premiums, and can prove vulnerable to more volatile markets. “We can not invest assuming that the world looks like the past 10 years”, he says.
Multi strategy and equities
Other long term holdings include multi-strategy platforms that make their own decisions on asset allocation and strategy selection, and often employ hundreds of specialist managers. “We are paying for the risk management function, and they have a proven risk management framework that can withstand volatility, rebalance the strategy mix, and recover well after setbacks”, he says. “Equity strategies have low or no beta because we can buy beta internally through index futures, so we would be more likely to allocate externally to equity market neutral, which needs to show idiosyncratic alpha generation”.
Ahonen is open minded about finding neglected emerging markets, but admits that it takes a lot of work to find niches not covered by the big multi strategy houses. He also does not expect emerging markets will be the first beneficiaries of economic recovery.
Credit and distressed debt
On the credit side, there are some relative value and arbitrage strategies, but there is also more beta to credit markets than in equities – and the managers also have a narrower focus. Ilmarinen is more likely to seek out specialist managers in emerging markets or certain geographic segments and has some based in the Nordics. “These relationships can be broader, for knowledge, value added dialogue, and we will sometimes coinvest alongside managers in certain opportunities”, he says.
Ahonen has allocated to distressed debt managers, but is not in any rush to increase this exposure by investing in the dozens of distressed funds being set up after the GCC. “We have a very conservative view on credit and do expect to see more distressed debt. But our only worry is it may be a bit too early to allocate to it. At best we see a multi-year timeframe for recovery, and at worst a prolonged slowdown and deleveraging cycle, which also implies a much longer distressed cycle”.
He does not expect central banks buying high yield debt will really be a “game changer” for the cycle, because the objective of these programs is more about backstopping liquidity than preventing defaults or bankruptcies: “central banks may improve two-way price formation in stressed markets times, but will not solve the solvency question for companies”.
Ilmarinen’s in house absolute return strategies have a limited overlap with the external managers. For instance, their equities sleeve is mainly using indices rather than single stocks.
But in common with outside managers, in house strategies are very much actively managed and subject to tight risk management: “the internal strategies are dynamic and flexible, using a mix of cash and derivatives. Capital is allocated to portfolio managers with strict drawdown and VaR limits”.
The internal strategies may sometimes have an advantage over external managers in being able to take a longer term view: “we have not had external exposure to tail risk funds as such, though the in house strategies do include portfolios of long convexity, long volatility strategies that might be classified as ‘antifragile’. We are seeking out some ‘endowment trades’ in rates and FX that are too long term for most hedge funds but can be a good fit for pension funds, and offer long volatility exposure in a smart way. These might include yield curve convexity or FX forward volatility trades expected to mean revert over a few years, that offer positive carry during the wait. In my opinion some of these time varying risk premia offer a lot of information with a genuine bias to being too cheap. I especially like the diversification benefits during times of increased realized volatility.”