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Wealth Manager: Heptagon CIO Gandon explains why equity beta is critical

Wealth Manager: Heptagon CIO Gandon explains why equity beta is critical

Arnaud Gandon, Heptagon Capital’s soft-spoken chief investment officer, credits spending the first five years of his life in Gabon for helping develop his love of travel and interest in other cultures. That does not, though, extend as far as having a desire to spend any more time than strictly necessary in Geneva.

Following a parabolic rise through the ranks of Union Bancaire Privée (UBP), which saw him appointed head of global equity at the then rapidly growing bank while still in mid-30s, it was the realisation that his career path could only end in the sleepy Swiss Canton that prompted him to reconsider its merits.

‘They wanted me to spend a lot of time in Geneva, and in the end move there, and I didn’t really like Geneva,’ he says. ‘It’s quite amazing, people saying that all the bankers are going to want to go to Switzerland. It’s nonsense – London is an international city and I like my life here, my wife is English.’

Fortunately his desire to stay coincided with Heptagon Capital’s desire to expand its private client offering from its historical background in institutional assets, and the firm proved receptive to his clearly defined core-satellite blend of quant and qualitative investment process.

It probably helped that by the time he joined in mid-2010, he had a pretty convincing case for its merits: a five year track record of returning an annualised 11% versus 0.4% return per annum for the MSCI World over the same period. 

‘[UBP] was the kind of place where you could grow, and grow with the business,’ he says of the eight years he spent with the company, then experiencing a period of rapid expansion. His stint there involved managing the long-only global equity component of multi-asset institutional mandates.

 

A large amount of UBP’s reputation was within fund of hedge fund and long/short strategies however, and the company has had to re-orientate its business as investors have lost their taste for high-margin complexity.

If we minus the complicated derivative strategies, that description of a business at the sharp point of the bell curve could equally well apply to Heptagon.

The business has $5.8 billion under management, split between $900 million in packaged Ucits funds, $700m from private clients and the remainder being institutional investors.

Overall asset growth stands at around 75% since 2010, while private client assets have doubled. The company offers pure investment from a minimum of $5 million charging a clean 1% AMC – it doesn’t hold asset custody, so any other charges are subject to the holding institution, although Heptagon will help to negotiate what it considers fair terms on behalf of clients.

The business employs 22 people, including five investment specialists, three partners and two administrative staff, with the remainder in relationship roles, looking after 245 clients.   

Born just outside Paris, Gandon spent his early years in the French equatorial African state of Gabon, where his father worked as an accountant under a French government technical assistance scheme, although he says he remembers little of the period.

Returning to France, he was inspired to specialise in economics by an ‘inspirational’ teacher, Michel Barnard, who later served as economics adviser to the Sarkozy administration. He sat finance at the Ecole Supérieure des Techniques de Gestion in France before moving to London in a position on Merrill Lynch’s prime brokerage desk.

He then moved on to a position as a trader with Crédit Commercial de France before it was taken over by HSBC, and he moved on to the buy side with several portfolio management roles before joining UBP in 2003.

‘I guess I always wanted to manage portfolios but a lot of it is about the people you meet. People always talk as if their career plans were a straight line, but I think it is sometimes more about people who inspire you to take an interest in something.’

It was at UBP, with its internal emphasis on derivative techniques, modelling, hedging and complex risk controls, that he began to form his investment process, on a mandate which was successful enough to be launched as an open-ended investment company.

In collaboration with the partners and co-manager Alexander Gunz, Gandon runs a core of high conviction, long-term managers, who are all selected for their ability to return consistent alpha.

Around this, the company builds strategic satellite positions, with between 15% and 20% in directional passives to capture market beta. Even factoring in the quasi-trading strategy, turnover remains fairly low, at between 35% and 40% of the portfolio a year.

 

‘In terms of asset allocation, the most important contributor to returns is always going to be equity beta. We build a core and satellite around those principles, with passive exposure to capture market beta.’

Active fund selection is managed in-house, while the quantative beta strategy is based on a model developed by a tiny French modelling house, which he considers important enough to the business’ unique proposition that he asks it remain unnamed.

‘What is important is to do your homework – we do a lot of due diligence. [The quant team] compare valuation, liquidity and risk. If we are satisfied with these three criteria then we add to risk. The question they ask is why should you own equity, are you getting the return that justifies the volatility? They look at five or six critical factors, such as dividend yield versus bond yield, and liquidity, which is critical to understand whether things are cheap, or if they are priced for a reason.’   

Looked at over a 30-year term, the modelling does appear to offer a pretty defined guide, moving to strong and definite sell signals on valuation grounds in the late 1990s. Since 2005, the movement has been almost binary between strong buys and sells, with parabolic moves between strong points of conviction. Although the buy signal has wobbled around conviction recently, as compelling valuations ran up against liquidity draining out of world markets.

‘It can be early or late, but it is intended to be a long-term indicator. It would have told you to sell early in 2006, and on valuation and liquidity as QE2 was being pumped in, to buy early in 2009. The important element in recent years has been liquidity.

‘A lot of people last year said valuations were cheap, but [the quant model] could see liquidity being taken out of the market, and it very clearly said in 2011 to not take risk in Europe, as credit growth was non-existent.’

Despite the European Central Bank’s actions flooding the market, the indicator has still not normalised, owing to the fact that credit growth continues to retract.

‘Liquidity has improved, but banks are still not lending: it has flipped, but it is not a screaming buy.

 

'It has offered a clearer guide to emerging markets, though, as the reflation of Europe will definitely have a positive impact on equities globally.’

More qualitatively, the firm has added to both credit and equity risk across the developing world, and added directional equity on positive news from the US. Away from the immediate business cycle, the company has a big thematic position in shale gas, which Gandon says yields a number of potentially exciting secondary investment ideas.

‘There are a lot of issues which remain to be resolved, but it could be very exciting, with a significant impact on the [US] trade deficit and the dollar – they could be energy independent within 20 years. The potential [energy] reserves are huge.’

The US is a large component of the active portfolio. Alongside the unnamed quant team, Gandon says Heptagon’s second major unique selling point is its fund research capacity. This explicitly seeks out managers offering genuine differentiation to the UK market.

‘We have a sweet spot of managers with minimum [assets under management] of $250 million to $1 billion – they tend to be well motivated to offer genuine returns and have their interest aligned with clients’.’

Top of his current conviction buy list is value fund Yacktman US Equity, managed by Don Yacktman in Austin, Texas, which Heptagon appreciated sufficiently to bring to the UK in a Ucits wrapper. Yacktman is the best performing US large cap value manager over 15, 10, five and three-year periods, and has performed more consistently than Berkshire Hathaway over that period.

‘He ticks all the boxes – he owns the business and has a great track record. He is at the larger end of our list, he manages more than $10 billion now, but he is not a big name outside of the US.’

Also at the top of the buy list is the Muzinich Short Duration High Yield fund, managed by Muzinich & Co of New York.

‘There are very few focused, short-dated high yield funds and this is a very interesting product – if you are worried about rates going up, it’s a good idea to have short duration bonds.’

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