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“Sustainability will ultimately determine our development” – an interview with Carolina Minio-Paluello
Article published in Sphère, January 2019
In your view, what are the main changes that have impacted the asset management industry over the past five to ten years?
First, I believe we're currently witnessing a polarisation of the sector. Passive management is growing based largely on lower costs, while we're also seeing the emergence of increasingly specialised active management according to strong convictions, where asset managers can make full use of their risk budget.
A second trend that I feel is important is institutional demand for ultra-personalised solutions. The investment strategies of insurance companies, sovereign wealth funds and central banks are becoming increasingly complex.
A third trend worth mentioning is the distribution of funds by third parties, including private banks, who represent roughly half of our assets under management. The implementation of Mifid II and its impact on retrocessions are having a significant impact in this area, where our clients want to reduce the number of asset managers they work with as far as possible. They also prefer to develop closer partnership-type relationships with us and, here again, we're keen to offer them innovative solutions and new ways of interacting.
What trends do you want to exploit in the next few years?
It's clear to us that sustainability, or ESG as others call it, has become a fundamental growth driver for our industry. Far from being a passing fad, it heralds major upheavals in many parts of the economy and is an aspect that we've had to integrate in a very structured way since it affects all our business lines. We also firmly believe that integrating sustainability will be a key source of return for investors in the years to come.
Lombard Odier Investment Managers is currently structured around five franchises: equities, convertibles, fixed income, multi-asset and alternative. We've therefore integrated sustainability at the core of our long-only strategies and are working on doing so for our alternative strategies. We couldn't simply apply a few ESG principles here and there just to cover some of the portfolios. We wanted it to define our entire offering, and it seems obvious to us that it will ultimately place conditions on our growth.
How have you integrated it into your investment strategies?
Our approach is based on three pillars. The first looks at the sustainability of the financial model, the financial structure. This is the best starting point. In the case of equities, for example, companies with higher profitability will outperform, and we focus on cash flow generation, capital efficiency and market dependence. However, this is not enough to control all the parameters that determine the growth and evolution of a company.
We therefore added a second pillar, which assesses the good conduct of companies according to ESG standards. This is far-reaching work that Lombard Odier has been doing for 20 years now thanks to the commitment of the Partners, who understood the challenges related to this issue very early on. The ESG analyses we produce are now available in the cockpit of all our asset managers.
We also added a third pillar that we considered just as essential: the sustainability of the business model. We want and need to understand how companies intend to adapt their strategy to a fast-changing global environment. They are facing rather powerful structural trends, and we want to ensure they are able to manage their transformation.
We therefore combine these three pillars, these three information flows, in our investment decisions when deciding whether to buy or sell. We've made very good progress with the first and second pillars, and will be investing a lot in the third pillar to perfect the study of business models and their evolution.
When talking about sustainability, you go so far as mentioning a revolution. How do you justify using this term?
We don't hesitate to talk about revolution in the case of sustainability because it's taking on an importance comparable to that of the industrial revolution and is spreading at the speed of the digital revolution! It takes full advantage of the pressure that is now being exerted at various points.
First, social consciousness has grown considerably and is now capable of initiating significant changes on major social issues, such as global warming and inequality.
Then there is a political agenda and the drafting of new laws that ratify these changes. I'm thinking here specifically of COP21, but I could also mention diesel in the automotive sector or sugar in the food sector, which is another sensitive issue.
Finally, investors will play a key role. They are no longer mere observers. They will favour companies capable of changing both their business practices and their business models in their allocations in future – and have already started to do so. Those who don't play the game may disappear.
How concerned do you think investors really are?
Fewer than 5% of the calls for tenders we responded to in 2017 included ESG questions, but this had risen to almost 40% in 2018!
Aside from this 40%, which three figures best sum up 2018 for Lombard Odier Investment Managers?
It was a very good year from a portfolio management perspective, with two-thirds of our funds outperforming their benchmarks. So that's the first figure. The second is the dozen employees we recruited in Sales & Marketing this year to roll out our sustainability offering. Now that we've reconfigured it and have a great story to tell our clients, we can focus on marketing it.
But I think the last figure is the most important: the proportion of our different business lines that now include ESG. 90% of our mainstream offering now includes all three sustainability pillars, which perfectly reflects the direction we want to give Lombard Odier Investment Managers. The world is changing, society is changing, the economy is changing, and we too are opening up new avenues for our investors.
How do you see the economy developing in 2019? What scenarios do you predict?
The outperformance of the US financial markets was the highlight of 2018, but we believe this trend will reverse. The economy is entering an end-of-cycle phase, and the effects of Trump's fiscal stimulus are coming to an end. However, we are also seeing a significant decoupling from emerging markets. Trade tensions between China and the US are expected to ease.
We believe this is perfect timing for a strategic allocation to emerging markets. The correlation between debt and equities here has declined significantly, particularly for countries with strong currencies. Combinations to obtain more diversified allocations and more stable portfolios are also becoming more attractive.
What is your outlook on fixed income?
The environment isn't ideal. Liquidity and interest rate risks are high. That being said, we are interested in one particular sector, namely BBB, BB and crossover ratings, which are between investment grade and high yield. This sector offers a good compromise between credit and duration. The returns are extremely attractive, and the default risk is very low.
From a more general point of view, we're focusing more on drawdown management in equities and are talking much more about convexity with our clients, who are showing a keener interest in niches such as convertibles. They're looking for innovative solutions with a more pronounced decorrelation in response to current uncertainties. It's probably more necessary now than ever before to be highly creative in the world of asset management.
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