Since the emergence of “Modern Portfolio Theory” and the “Capital Asset Pricing Model” in the late 1960s, institutional investors have taken a quantitatively driven approach to portfolio construction, looking to create portfolio diversification and obtain better risk-adjusted returns by balancing their asset-class exposures. This journey has seen several important advancements in thinking about how to optimally achieve desired results.
Funds that want to take the total portfolio approach first need to get the total portfolio view. To do that they not only need data – and lots of it – but a rock-solid understanding of exactly how they’re going to use it.
BlueCove banks on volatility for a fixed income renaissance
The still nascent systematic fixed income space is expected to expand as market volatility rises and big institutions look beyond their fundamental managers to get returns.
“A fundamental manager usually delivers alpha in up markets – not very surprising,” says Ulrich Koall, head of business development at BlueCove. “We’ve had bull markets in fixed income for the last umpteen years. A systematic manager drives its alpha off volatility – and volatility in credit is high in down markets.”
“From a macro point of view, we think that’s a scenario very likely to happen in fixed income markets over the next 6-12 months; we think that default rates will rise in both Europe, which is already in a recession, and the US, which is slowing down. And there’s a wall of money in high yield that needs to be refinanced.”
BlueCove was founded and funded by Hugh Willis and Alex Khein, respectively co-founder and chief executive of BlueBay, which was acquired by RBC in 2010 and for which BlueCove is named in honour of. It’s a standalone, systematic fixed income manager – and with interest rates now rising from an extremely low base, it’s expecting a “renaissance” in public fixed income.
“Not only because short yields are up, but because the whole yield curve has shifted to levels where public fixed income can compete with private credit – and so the asset class is back en vogue,” Koall says.
While systematic equities managers often face rapid decay in the strength of the signals they use to inform buy and sell decisions, BlueCove hasn’t had to retire a signal since its 2018 inception because of the relative lack of competition in the space; most systematic fixed income teams work in the confines of larger managers like BlackRock or Robeco, while more direct competitors like AQR have been forced to shut their own divisions down.
“In the equities space you’re talking about alternative data sets that people are using, and they’ll pay a lot for them,” Koall says. “We use alternative data, natural language processing of conference calls and artificial intelligence. Do we need it at the moment to build models that have a high information ratio in this space? Absolutely not. The competition isn’t dense enough for that signal to get arbitraged away.”
BlueCove also “very rarely” discovers new signals. Only around five per cent of them are interesting, and most of the new discoveries are additive. But on a standalone basis they’re not very decisive, and unlike some equities quant shops BlueCove wants the signals it uses to be explainable by economic theory or corporate finance; they don’t use dummy variables.
“Implementation is key in fixed income,” Koall says. “We do not trade straight through like in equities; everything we do in the model portfolio is manually checked by the portfolio managers in terms of the rationale and the implementation feasibility… We can only do that if we understand what a signal means.”
BlueCove is looking into building a local presence – it already manages two mandates on behalf of local institutions – and opening wholesale vehicles for its funds, while in the institutional space there’s “still much to do”.
“We’re seeing more search activity in this space, and we provide an alternative to the fundamental fixed income management PIMCO, Western Asset Management, you name them, provide to the market,” Koall says. “
