Panagora Asset Management: Eric Sorensen, chief executive officer

nrpn: What would you say is the most common mistake institutional investors make with their portfolios?

In general, the framework people have been using has been too traditional and the asset allocation too basic. Now Nordic investors, for example the Swedes, have moved in the right direction by trying to separate alpha and beta and are looking more intelligently at that mix. The problem is everything is correlated with equities. If you have a large allocation to equity in your portfolio, you’re going to make money on the way up, but if there is a market correction or crash like in 2008, you will lose a lot of money across your asset classes when equity markets go down. So, I think the whole notion that schemes should be benchmarked to a major stock exchange or index is a mistake.

nrpn: How have Nordic institutions reacted to quant strategies?

Nordic institutions, along with Dutch investors, in general are more sophisticated and knowledgeable investors than other European institutions on quantitative investing. They were some of the first institutional investors to invest in quant and understand the notion of risk control. They also understand what it means to try to achieve incremental return and have hired a lot of managers that use quantitative techniques.

nrpn: What would you say is the main weakness in a quant strategy?

One of the problems with quant strategies is the so-called quantitative ranking systems and optimising portfolios that try to eek out alpha. In the early days, maybe 20 or 25 years ago, that was a reasonable endeavour and you could actually achieve some extra returns with fairly straightforward techniques using publicly available databases. A lot of money flowed into those strategies, so one of the weaknesses was that the market became overpopulated. There were too many quants chasing too many factors. All the big firms got into it and it just exploded. That all changed in 2007 when there was a lot of volatility in those strategies. This exposed another weakness, which was that quant strategies were too rigid. They don’t adapt to an environment. It’s a formulaic approach to every stock and bond where you buy the high-rated securities. And by doing that, and with others doing it, the strategies fail.

nrpn: So what are quant managers doing about that?

The market has become efficient, but too rigid. We have done a lot of research and a lot of what I call fundamental investigation into what kinds of strategies and concepts make sense when selecting and buying assets. We’ve moved away from some of the old plain vanilla techniques. While traditional things like value, momentum and quality are still important factors, we’ve gone way down to look at individual sectors and groups. For example, one of our analysts is a specialist in medical technology and pharmaceuticals. In the old days we’d just buy a lot of pharmaceutical companies that had good cash flow and that were reasonably cheap. Today, we’ve got ingredients and models that don’t have anything to do with where they trade in the market and have everything to do with their patents and expiration dates. Much like a fundamental analyst, we tend to systemise it. Quant techniques are there and they work, but they have to have the right ingredients.

nrpn: How do you respond to allegations that quant managers were responsible for the financial crisis and that they created the complex investment models that caused many of the problems?

I totally disagree. Quant models tend to be backward-looking, and the crisis was certainly not a result of quantitative management. I think a lot of factors played a much larger part, such as excessive debt levels and people buying houses they couldn’t afford. Governments made it very attractive for people to take on loans they shouldn’t have. So blaming quants for the crisis was overdone.

nrpn: A lot of Nordic pension funds lost large amounts of money during the crisis because they stuck to their strategies. What is your view on that?

I still think their attempts to distinguish their risk premium beta exposures versus the risk of hiring active managers were, and are still, the right strategy. In the post-crisis era, they are doing a better job of understanding what they need to do with their alpha portfolios. Now they are asking how they should mix their managers together in this portfolio, how should they look at the risks and how they should monitor these managers. On the beta side, they know it is a different proposition, but sometimes they aren’t managing this portfolio as effectively.

nrpn: Some investors are focusing on having a constant risk level in their portfolios instead of a constant asset allocation. Do you think that’s a better way to go?

Again, I think the risk budgets used are a little too traditional and this applies to the way institutions invest across all asset classes. Risk budgeting has been based on concepts and notions that aren’t necessarily right. There’s a notion that you want to have 20 per cent to 40 per cent of your risk in equities. But if you do that, you probably have a lot more risk than you realise because equities are the most volatile asset class. Risk budgeting is talked about a lot, but I think that trillions of dollars out there aren’t run properly. They’re run by trustee boards that tend to stick to what they know.

nrpn: Have you been seeing more interest in liability driven investment strategies, not just in the Nordics, but around the world? And what is your view on this strategy?

Definitely, and it’s because a lot of these funds are underfunded. This is a bigger issue in the US, but many schemes around the world had a surplus and now it’s gone. So what should they do? We’ve been involved with a number of institutions around the world, looking at creative overlay strategies that try to achieve more returns with less volatility. It goes back to the risk budgeting approach I mentioned earlier. We’ve been talking about this strategy for the last three or four years and finally in the last year there has been a significant increase in interest in liability driven strategies. But sometimes scheme trustee boards are not that sophisticated and don’t understand these strategies so they hold back.

nrpn: Is there one country in the Nordic region where you have found it easiest to do business?

In our case, Denmark has been really great. I have a Danish name and relatives there, so maybe that helps. But we had some products and emerging market strategies that they really seemed to like, and so we started spending a lot of time in Denmark. A couple of their institutions are really at the cutting edge, but I wouldn’t say Denmark is the most sophisticated country. You can find sophistication in all the Nordic countries.