Likewise, when a large pension fund, insurance company or corporation has liquidities to invest such that it will be able to cover long-term commitments without excessive risk, it seeks appropriate advice. This could include input from highly qualified domain specialists like the BNP Paribas Asset Management Solutions and Client Advisory group, who in turn consult their colleagues within the Quantitative Research Group’s (QRG) Tailored Solutions and Asset Allocation team. And here, the client organisation finds the diagnosis and prescription it needs to secure and grow its money well into the future.
“We’re like family financial planners - on a larger scale”
is how Koye Somefun, head of QRG’s Tailored Solutions group describes the role.
“Our business is all about finding the best ways to invest money when you know in advance that you’re going to have future expenditures—like pension payments or insurance outlays. We don’t aim to outperform a given equity fund or maximise returns at all cost. Instead we seek to align an organisation’s investments as closely as possible with its goals over time. This involves using quantitative methods—algorithms and computer modeling—to create new and review existing strategies designed to ensure continuing alignment with future goals.”
As Koye Somefun explains that Tailored Solutions’ clients usually have a host of variables that impact the ways in which they are able to invest their assets. For example, both pension funds and insurance companies must adhere toh extensive government regulation designed to protect the consumer—such that pension funds are able to finance their sponsors’ retirement years as originally promised, and such that insurance companies are able to cover their commitments when claims are made.
“These government regulations are complex and different in every country,” says Koye Somefun. “They impinge significantly on how an organisation can invest its money and they limit its ability to take risk. Our team must have a comprehensive grasp of all the regulations in order to find and propose the best solutions to a client. It can be a tricky assignment.”
Corporate clients also have constraints on what they can do with their assets - “they have more freedom from a regulatory point of view, but they need to answer to their shareholders and use assets in accordance with what the shareholders decide. So they tend to take little risk with the assets they have in their balance sheets, and they tend to invest almost exclusively in low risk financial assets.”
When taking all these constraints into consideration, what kinds of strategies can Koye Somefun and his colleagues employ to ensure steady returns and limit risk?
One such tool is an equity overlay, which is a derivatives-based product that asset managers use to reduce a portfolio’s exposure to equities when the risk associated with those equities increases.
The fall in valuations of equities in late March triggered by the COVID-19 pandemic provides a good example of how a well-designed equity overlay would have worked. In this case, the successful overlay would have reduced risk exposure at the beginning of the pandemic, when market prices began plunging, and would have increased exposure to equities two months later, when markets started rising again. By using derivatives, the equity overlay avoids the considerable transaction costs associated with the actual buying and selling of large numbers of stocks and bonds.
“But not all equity overlays are alike,” warns Koye Somefun. “On the contrary, every overlay is built differently depending on the client portfolio’s specific goals. That is the essence of what we do. We tailor investment solutions, using a variety of financial tools including equity overlays.”
The Solutions and Client Advisory team has been working with pension funds and insurance companies for decades now, but more recently it identified a new type of client with large infrastructure installations that have limited lifespans. Because such structures cost a lot to decommission, the companies involved need to plan decades in advance, setting funds aside and investing it in such as a way as to have enough capital to pay for decommissioning when the time comes.
“This industrial domain is generating a lot of new activity” says Koye Somefun. “We work hand-in-hand with the Solutions and Client team, using simulations to determine which strategies are most likely to deliver the right result. Should all the money be invested in a bond that will deliver the expected cost of decommissioning? Maybe, but that might require too much capital at the outset. Should some capital be invested in equities to reduce the initial capital outlay, since equities tend to have higher returns than bonds? Maybe, but how much? These are the types of questions we toil with every day.”
Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients.
The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns.
Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions).
Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.