History and math are two subjects Greg Tournant knows cold.
They also happen to be the driving force behind the alternative investment strategies he runs for Allianz Global Investors. Conducting in-depth analysis of historical price movements—as far back as 1929—and applying a proven mathematical model to trading options are part of Tournant’s core curriculum. These quant underpinnings, when combined with his skill in building profitable positions, are a difference maker.
Today, investors are hungry for less-correlated assets that help combat steep market drops but without the complexity and fees you’d find in a hedge fund. At the same time, they’re skittish about owning what they don’t know. But Tournant’s brand of alternative investing relies on familiar ingredients: plain-vanilla options on the largest US equity indices. With no financial leverage, either.
Tournant explains in an interview why options can be strong diversifiers for bond investors who worry about rising rates and stock investors who fear another 2008.
Liquid alternative investments have gone mainstream in recent years. What's driving demand?
The appetite for liquid alternatives stems from financial advisors' need for portfolio returns that are uncorrelated to stocks. Advisors also want returns that are not dependent on the direction or level of interest rates. They're working with clients to answer the question, "What can we do to help you achieve greater diversification with less risk?" The stock market has disappointed a lot of people over the past 10 years. Bonds are also cause for concern because record-low interest rates are expected to rise. As a result, we've seen a wave of alternative strategies in '40 Act mutual funds come to market.
Alternative investments mean different things to different people. Is there a simple way to define the universe?
To us, an alternative investment is any strategy that can make money regardless of whether the market is up, down or flat. It's also one that has an asymmetrical risk-return profile, low exposure to market beta and a higher Sharpe ratio than traditional asset classes. For example, it could be an investment that captures more of the upside of the S&P 500 and less of the downside.
Alternatives have come into focus with the rise of the endowment model made popular by Yale's David Swensen. What diversification benefits do they offer?
Their risk-reward profile is more attractive—the return an investor can get per unit of risk is higher. But it's not just about delivering something different; it's about delivering something better. Investors have to ask themselves if they're comfortable with their equity allocation, given stocks' potential for extreme volatility, or with their fixed-income allocation, given that interest rates are likely to rise. Even if you expect the stock market to perform well over the next 10 to 15 years, a 40% decline at any time during that stretch can wreak havoc on your portfolio. An allocation to the proper alternatives strategy can help soften the blow.
Post-2008, investors are now more risk-averse. How do you strike the right balance between downside protection and generating positive returns?
In AllianzGI Structured Alpha Fund
, the goal is to provide an all-weather, no-excuses stream of returns. We're supposed to make money rain or shine, with low or no correlation to stock or bond markets. At the same time, it has built-in tail-risk protection. It's designed to withstand crash-like events, like the one in October 1987, by minimizing losses during market declines that cannot be statistically forecasted. The portfolio continually aims to strike the right balance between generating consistent returns and having downside protection. And certainly, the past seven and a half years—we've managed the Structured Alpha 500 strategy for institutional clients since 2005—have been a great stress test.
How can options help protect investors from catastrophic events or tail risks?
We can't predict the next crisis, but we have to be prepared for it, so we spend a lot of time on what-if scenarios. Some of our positions, like long put options, are designed solely to protect against a crash. Options are like Legos—you use them to construct something one piece at a time. And you can add and remove those pieces, in this case to increase or decrease risk, as you go. Managing AllianzGI Structured Alpha Fund requires a balance of buying and selling options simultaneously. The trick is not to create a zero-sum game.
What's your team's experience in the options market and with managing money?
We're battle tested, for sure. At $1.4 billion as of 3/31/13, the AllianzGI Structured Alpha platform* is one of the largest pure-play option strategies in the marketplace, and we've been able to consistently deliver on our return target since launch in 2005. Our team has been together a long time, and I was personally involved in the research and development of the platform for several years before launch. There's a lot of research and a lot of math behind it, and it has paid off. We've been able to navigate the extraordinary range of environments and market shocks of the past seven years, all while delivering a consistent return.
What do you look for before buying or selling options?
First, we look at history. A keen understanding of market history is the foundation of AllianzGI Structured Alpha Fund's competitive advantage. We conduct an in-depth statistical analysis of equity-market movements dating back to 1929. Second, we extract statistical patterns that have a high degree of recurrence. This allows us to forecast high-probability ranges for index movements. We're not looking to predict the market, just to come up with an objective, statistical view of how much it might move up or down over the next, say, two months. Then the third step is to build an options portfolio to take advantage of our statistical insight. If the equity index ends within our forecasted zones, then we should make money.
Retail investors have some hang-ups about alternatives. Why might they be less intimidating than they think?
Our strategies are not race cars looking to speed their way to high returns. They're four-wheel drive vehicles designed to tackle tough terrain. We use simple instruments to pursue returns based on the performance of the largest US stock indices: S&P 500, Nasdaq 100 and Russell 2000. These are plain-vanilla, transparent, exchange-traded options. It's not the ingredients that are complex, but how they're mixed together. A French chef goes to a local grocery store to pick up the items that everybody else has access to, but the chef will be able to cook a meal that tastes a lot better. That's what we're doing.
How do these strategies—AllianzGI Structured Alpha Fund and AllianzGI U.S. Equity Hedged Fund—differ from their peers in the long/short category?
We consider volatility its own asset class; that's our niche. Compared with many other options-based mutual funds in the long/short category, our ability to combine simple instruments in a more sophisticated and risk-controlled way—and with no financial leverage—gives us the potential to deliver more consistent performance.
Where do these strategies fit in an overall asset allocation strategy?
Absolute-return strategies have a place in any asset allocation. A strategy that can generate returns in an uncorrelated way makes the total portfolio better. This idea is widely recognized and is now being implemented more broadly. From our perspective, if you want to reduce your equity or fixed-income risk, but still want your assets to grow, then AllianzGI Structured Alpha Fund is a terrific choice.
What about AllianzGI U.S. Equity Hedged Fund?
AllianzGI U.S. Equity Hedged Fund
is an equity strategy in which we use options to try to reduce downside risk, while preserving upside potential. The goal is to give equity investors a better experience than they can get with a traditional stock portfolio. The basic premise is asymmetry—to provide a floor on your equity exposure with no outright ceiling. We protect against market declines by owning put options, so if the market is down 30%, this portfolio could be down just 8% or 10%. But if the market is up 30%, depending on the path of the index, we might be up 25% or even the full 30%.
How much does central-bank intervention, specifically financial repression, impact the ability to deliver absolute returns?
We're designed to deliver returns regardless of the environment. That said, if we had our choice we would pick a higher-volatility environment. So the fact that the Fed has been providing a lot of liquidity that is muting volatility is of no benefit to us. If short-term interest rates were to go higher, then it would boost our stated total-return target. But rest assured, there are enough structural imbalances and disruptions in capital markets that we're likely to get another wave of volatility. And volatility is our friend.
Alternatives like 130/30 funds had a lot of cachet back in 2005. Many of those funds have either underperformed or since disappeared. What will separate the winners from the losers in today's alts space?
Consistency of returns. It's true that a meaningful percentage of hedge funds and hedge-like strategies have disappeared. That was one way to take out the managers that didn't have the skill or the financial wherewithal to compete. Ultimately, the market will take care of itself. There's enough appetite for alternatives that if you have a good track record, transparency and liquidity, then you should do well. Plus, a lot of good hedge funds can't offer their strategies in the '40 Act space because of their investment characteristics or legal restrictions. We can.
*The Structured Alpha platform includes the following AllianzGI strategies: Structured Alpha U.S. Equity 250, Structured Alpha 500, Structured Alpha 1000, Structured Alpha U.S. Equity 500 and Structured Alpha 10 Year Treasury 500.
Investors should consider the investment objectives, risks, charges and expenses of any mutual fund carefully before investing. This and other information is contained in the fund’s prospectus and summary prospectus, which may be obtained by contacting your financial advisor. Click here for a complete list of the Allianz Funds prospectuses and summary prospectuses. Please read them carefully before you invest.