The Interview – Michael Azlen, Frontier Investment Management: “We expect more multi-asset offerings launched and a drive to lower costs”
Michael Azlen, founder and executive chairman of Frontier Investment Management, says the investment proposition behind the firm’s passive multi-asset funds, encompassing eight asset classes, is based in part on the diversification benefits of combining traditional and alternative asset classes, a philosophy similar to that of US university endowment funds.
GFM: What is the history and background of your company, principals and funds?
MA: Frontier Investment Management was founded in 2004 to deliver a unique multi-asset investment proposition to the institutional, high net worth, private banking and IFA marketplaces. Previously, an endowment-style approach to multi-asset investing, with a strategic asset allocation across both traditional and alternative asset classes, was only available to institutions and ultra high net worth individuals. Frontier was the innovator in making true multi-asset investing passive and low cost.
The Cayman-based Multi Asset Platform Fund SPC, launched in September 2005, provides investors with a globally diversified portfolio that has exposure to eight major traditional and alternative asset classes in one fund: global equities, global fixed income, emerging equities, emerging bonds, real estate, commodities, hedge funds and managed futures. The fund, managed by Marc-Phillipe Davies and listed on the Irish Stock Exchange, had USD405.9m in assets under management at the end of February.
An FSA-authorised fund (IFDS Frontier MAP Balanced Fund) with an investment strategy consistent with the Multi Asset Platform Fund was launched in March 2009. Also managed by Marc-Phillipe, it had assets of GBP86.5m at the end of February.
The IFDS Frontier MAP Cautious Fund was launched in February this year with GBP2.1m in asserts to offer an asset allocation targeted at investors with a lower appetite for risk than the IFDS Frontier MAP Balanced Fund.
The Irish-listed FrontEdge Global Hedge Fund was designed as a liquid and diversified method of accessing the hedge fund asset class at comparatively low cost by blending synthetic replication with investments in single-manager hedge funds. Managed by Alex Gaitan, it aims to outperform the global hedge fund industry on a risk-adjusted basis. The fund was made available to external investors in April 2009 and had USD82.4m in assets at the end of February.
The FrontEdge Managed Futures Fund , also listed on the Irish Stock Exchange, is a liquid and diversified fund of CTAs. Managed by Alex and co-managed by Marc-Phillipe, it provides investors with an efficient means of accessing the managed futures asset class, and aims to outperform the managed futures industry on a risk-adjusted basis. The fund was launched November 2010 and had assets of USD56.9m at the end of February.
GFM: What is the structure of your funds?
The IFDS Frontier MAP Balanced Fund and IFDS Frontier MAP Cautious Fund are UK-domiciled Non-Ucits Retail Scheme, while the Multi Asset Platform Fund, FrontEdge Global Hedge Fund and FrontEdge Managed Futures Fund are Cayman-domiciled UCIS structured segregated portfolios within the MAP Fund SPC.
GFM: Who are your main service providers?
MA: For the Multi Asset Platform Fund, FrontEdge Global Hedge Fund and FrontEdge Managed Futures Fund, the administrator is HSBC Securities Services (Ireland), the custodian is HSBC Institutional Trust Services (Ireland) and the auditor is Ernst & Young.
For the IFDS Frontier MAP Balanced Fund and IFDS Frontier MAP Cautious Fund, the authorised corporate director is IFDS Managers, the fund accountant and custodian is State Street and the auditor is Deloitte.
GFM: What is your distribution strategy and targeted client base?
MA: Currently, the funds are primarily distributed within the UK, although we do have investors across Europe and the Middle East. The majority of investments have come through UK-based financial planners and intermediaries, providing the funds with a stable and diversified base of assets. The offshore multi-asset fund has a white label arrangement with National Bank of Kuwait. The funds also manage money for family office and high net worth investors.
GFM: What impact has the recent global financial crisis and economic downturn had on your business?
MA: While Frontier was not immune to the global recession, our funds’ net asset values and assets under management recovered well. The funds experienced limited redemptions during the crisis, despite their excellent liquidity terms.
Some of the investment themes that have gained importance since the crisis, for example, portfolio diversification across a wide range of asset classes, a focus on reducing costs within portfolios, and the benefits of investing in managed futures, have always been part of Frontier’s investment philosophy, so there has been minimal impact on how the funds invest.
GFM: Please describe your investment process.
MA: The investment proposition behind the multi-asset funds is based in part on the diversification benefits of combining traditional and alternative asset classes, similar to US university endowment funds. Our investment philosophy is based on Frontier’s Four Pillars of Investing.
1. Traditional and alternative asset classes generate long-run real returns. They will generate a return above inflation (real return) and cash (excess return) over the medium to long term, five to 10 years.Alternative asset classes have embedded sources of excess return combined with attractive volatility and correlation properties.
2. Strategic asset allocation drives the vast majority of portfolio return and risk. Market timing and tactical asset allocation activities are unlikely to add value over time, and will increase cost and potentially increase portfolio risk.
3. Modern portfolio theory: diversification increases risk-adjusted returns. Diversification across multiple asset classes increases portfolio risk-adjusted return, creating a more ‘efficient’ portfolio. Leveraging or deleveraging an efficient portfolio is a superior method of changing the risk/return profile to altering the portfolio’s asset allocation.
4. Index investing outperforms the majority of actively-managed investments. Index investing captures the return of an asset class at very low cost and outperforms the majority of active managers; outperformance increases with time.
The objective of the multi-asset fund is to build a diversified portfolio consisting of multiple asset classes that will be as close as possible to the ‘super efficient’ or ‘market’ portfolio.
The asset classes have been thoroughly researched, and Frontier believes that each contains an embedded source of long-term structural risk premium. In addition, these asset classes exhibit return, volatility and correlation properties that add value to a portfolio. The result is a highly diversified portfolio composed of eight asset classes, both traditional and alternative, with access to the returns of more than 15,000 underlying securities and funds.
Frontier has chosen a highly diversified and replicable index to represent each asset class. The multi-asset funds employ an active indexing strategy in order to track asset class returns at extremely low levels of cost while maintaining low tracking error, high liquidity and low counterparty risk.
Frontier uses five main approaches to gain exposure to the underlying asset class returns: direct purchase of underlying instruments represented in the index; purchase of a futures contract linked to the index or a basket of futures; purchase of an index tracker fund (institutional pricing); purchase of an exchange-traded fund; and purchase of an OTC derivative linked to the index.
The investment decision as to which method to use for a particular asset class is determined by factors including tracking accuracy, liquidity, cost and risk. These factors are constantly changing due to market dynamics, which is why it is necessary to monitor all methods on a continuous basis and switch to the best method when appropriate.
The funds are managed on a currency-neutral basis by hedging the embedded global currency exposures of each asset class back into the reference currency (with the exception of emerging market equities).
GFM: What is your approach to managing risk?
MA: The strategy employed by the fund is based around asset allocation that in itself delivers return against low levels of risk or volatility due to low correlation across asset classes. Asset allocation is highly disciplined, with a detailed investment policy governing changes to the policy asset allocation.
The investment strategy itself provides a built-in volatility control mechanism by aggregating assets with different risk profiles and varied correlations. In doing so, we minimise the vulnerability of the fund to extreme changes in the markets by avoiding correlation to volatility events.
The securities held are mostly index-tracking instruments and index replication securities. The risk associated with them is market risk, which is mitigated by diversification.
Tracking error is managed actively and different OTC derivatives, ETFs, direct investments, and index funds have been used to minimise tracking error and maximise performance. Current portfolio allocations are reviewed on a daily basis and compared to the policy weights to identify discrepancies. Asset class weights are constrained to within five percentage points of policy weights at all times.
Counterparty risk is managed by trading with only investment grade-rated counterparties.
GFM: How has your fund performed?
MA: The multi-asset funds have delivered the returns of the indices that they track. They do not have a target return, but have target volatility of 5-7 per cent over five- to 10-year rolling time horizons (3-5 per cent for the newly-launched IFDS Frontier MAP Cautious Fund). This target is the result of detailed quantitative analysis of historical efficient portfolios.
While historically this target volatility had been achieved, volatility spiked during the 2008-09 bear market and has remained high. The annual asset allocation review in March 2010 therefore paid attention to reducing fund volatility while remaining consistent with the strategic, long-term and diversified approach exemplified by the US university endowment funds.
GFM: Are you looking at any particular opportunities right now?
MA: The investment committee constantly monitors the funds and the market to ensure that asset class returns are accessed in a cost-efficient manner. We would also consider adding new asset classes if they were proven to enhance the current portfolio.
GFM: What developments do you expect to see in your investment sector or industry field in the coming year?
MA: We expect to see more multi-asset offerings launched and a drive to lower costs. More funds coming into the marketplace will help to highlight our own proposition, which has a proven track record and a low-cost philosophy.
GFM: What do investors currently expect from managers?
MA: They expect disciplined risk management and sound operational processes. Those investing in actively-managed funds should also expect outperformance of the relevant benchmark.
GFM: What differentiates you from other managers in your sector?
MA: First is our track record. Over the past couple of years there have been a number of entrants into the multi-asset passive space. Frontier was the innovator in this area and now has more than five years’ experience in this space.
Frontier offer a true multi-asset proposition, diversified across traditional and alternative asset classes with an allocation inspired by US endowment funds such as those of Harvard and Yale. Similar to the endowments, the allocation to alternative asset classes is significant, particularly hedge funds and managed futures.
To our knowledge, we are the only multi-asset fund that includes an allocation (currently 17 per cent) to managed futures, which are a true portfolio diversifier. They have historically shown the lowest correlation to other asset classes and have provided positive returns in each of the five largest equity bear markets over 30 years.
Our asset class returns are currency-hedged to ensure that investors receive the true returns of the asset class without being exposed to currency volatility.
Finally, Frontier is committed to investor education and holds monthly in-house seminars covering the evidence behind our investment philosophy.
GFM: How do you view the environment for fundraising over the coming 12 months?
MA: Within the IFA sector, we expect to see an increasing number of advisers outsource all or part of their investment management function. We see this as a positive for our multi-asset funds, which are ideal as a low-cost, diversified core investment.
As our track record now exceeds five years, as our assets under management grow, we expect to develop other client sectors, including high net worth and family office investors.
GFM: Do you have any firm plans for further product launches?
MA: Frontier is committed to innovation in investment management. We expect to launch further funds in 2011, although none can be confirmed at present.
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