Olivier Davanne and Thierry Pujol : « Our investment process is carried out along with systematic evaluations of risk premiums !»

Within the framework of its exclusive partnership with DPA Invest which was unveiled last September, Groupama AM has boosted its range of expertise by proposing a new fund: Groupama Risk Premium. Its two co managers, Olivier Davanne and Thierry Pujol, have answered our questions.

Next Finance: Can you describe in more details your partnership with Groupama?

Olivier Davanne and Thierry Pujol : Groupama AM has sealed this partnership as a step forward in the framework of its objectives consisting of reinforcing and diversifying its offer. For DPA Invest, this exclusive partnership allows it to benefit from a prestigious partner that will allow it to deploy its offer in France and in Europe. As a first conclusive step of this partnership, Groupama AM has integrated within its product range, under the name of Groupama Risk Premium, the mutual fund managed by DPA Invest by taking into account the risk premiums available since December 2006. DPA Invest benefits from a conferral of management decisions and the fund will therefore be continued to be managed under the same criteria.

How is your investment philosophy innovative and how does it distinguish itself from the other common management styles such as flexible management most notably?

Thierry Pujol

What we have in common with a flexible management style is the absence of a strong benchmark constraint. But we have two specific qualities even if we must not be too general considering the strong heterogeneity of what is regrouped under the heading of flexible management. On one hand, we have an investment horizon which is probably longer than the average period over which flexible management intervenes. Therefore, the high price of the markets plays a bigger role in our investment decisions than tactical short term considerations. On the other hand, this particular insistence on high price questions comes along with systematic evaluations of risk premiums over different asset classes which, to our knowledge, are not carried out by any flexible fund on the French market

This particular insistence on high price questions comes along with systematic evaluations of risk premiums over different asset classes which, to our knowledge, are not carried out by any flexible fund on the French market

Olivier Davanne and Thierry Pujol

Can you define what you consider as “risk premium” and why you use this approach qualified as “risk premium” in the allocation process of your portfolio?

Risk premiums are a fundamental concept in finance. They measure the abnormal performance expected over the investment term of a risky asset compared to a monetary asset which does not hold any capital risk. This expected abnormal performance depends on the purchase prices and on the expected evolution of significant economic and financial variables which impact the returns of different assets (profits, monetary interest rates…). Risk premiums allow us to quantify the more or less high price of the markets and, to this regard, play a major role in the allocation process.

On which types of asset classes are you able to calculate a risk premium?

It is normally possible to estimate an expected long term return on any asset class and consequently deduct a risk premium. Right now and within the management framework of Groupama Risk Premium, we limit ourselves to the major worldwide asset classes: American and European equities (blue chips), government bonds (American, Japanese and Eurozone), the dollar and the yen.

What are the elements do you take into account for example when you calculate a risk premium on the foreign exchange market?

Olivier Davanne

The question that we ask ourselves, for example, on the dollar would be the as follows: what is the relative return that a Eurozone investor can expect over a certain period if he decides to carry out a monetary placement in dollars instead of euros? The difference in terms of returns, the risk premium, can be positive or negative. It has two components. First of all it depends on the expected spread on the monetary interest rates between the two zones. This is what is called the cost of carry which is positive on the dollar if the American monetary interest rates happen to be higher on average than the European ones during the coming years. But we have also to take in consideration the expected FX profits or losses while supposing that the FX rates come progressively back towards equilibrium levels which ensure adequate competitive levels to the different zones. Therefore, the evaluation of an FX risk premium leads us to ask questions about the medium term evolution of monetary policies in the different zones and on the most likely exchange rate equilibrium.

Do you have an index that acts as a reference? If yes, which one? If this is the case, can you specify the level of your “tracking error”?

Groupama Risk Premium is a total return fund which is internationally diversified and which does not have any benchmark constraint. If that was the case, it would be an obstacle to the need for rapid adaptation to the high price cycles of different assets. The fund’s target is to beat traditional diversified balanced funds (such as those having a 50/50 allocation in equities and bonds) over the long term. We consequently have a “balanced” 50/50 reference indicator (50% MSCI Europe Net Reinvested Dividends, 50% JP Morgan EMU) which is not an investment constraint but which provides an indication on the performances and the risk profile that an investor can expect when he invests in the fund. The “tracking error” is not normally defined and it has revealed itself to be quite large considering our management freedom (it has reached 8.6% over the previous year).

What is your track record since the creation of your fund in terms of performance and volatility?

Since its creation on the 15th of December 2006, the fund has produced a return of 6.1% (performance observed on the 31st of October 2011) with a strong varying volatility (the volatility level was small before the Lehman Brothers bankruptcy. It has been quite strong since then). Cumulatively over the 5 years (almost) of financial crisis, the performance has surpassed 8.7% which is that of its 50/50 reference indicator.

Groupama Risk Premium is a total return fund which is internationally diversified and which does not have any benchmark constraint. If that was the case, it would be an obstacle to the need for rapid adaptation to the high price cycles of different assets

Olivier Davanne and Thierry Pujol

Do you carry out short selling when the risk premium is negative?

Yes we do. This is currently what we are doing on German bonds and the yen. These two assets are acting as safe havens et look overvalued from our perspective over a medium term perspective.

How is your portfolio currently positioned considering the present lack of visibility on financial markets?

Short term lack of visibility is indeed exceptional considering the political obstacles in the United States and especially the governance crisis of the Eurozone. This leads several traditional flexible funds to decrease their activity. However, on the medium term, we consider the situation as having more clarity. The main Eurozone countries (Germany, France, Italy, Spain…) should carry out courageous public deficit reduction policies and improve the governance of the zone. Granted that this will not take place without political tensions, periods of high unemployment and strong market volatility but we believe that risky assets have a strong medium term rebound potential. Under those conditions, Groupama Risk Premium has increased its equity holdings during the summer (slightly more than 60% of the portfolio) by focussing more on American equities and by being short on safe haven assets as said earlier.