Lombard Odier switches bond funds benchmark

Lombard Odier Investment Managers has expanded the number of funds actively managed against its fundamentally weighted bond index.

Lombard Odier Investment Managers, the institutional asset management arm of Geneva-based private bank group Lombard Odier Darier Hentsch & Cie, has expanded the number of funds actively managed against its fundamentally weighted bond index.

The two funds, the LO Funds – Government Bond (Eur) and LO Funds – Inflation-Linked Bond (Eur), were previously managed against a traditional bond fund index. They join three other funds in the range: LO Funds – Emerging Local Currencies and Bonds, launched in 2010, with $810 million under management; LO Funds II – Global Government Bond, with assets under management of $234 million; and LO Funds – BBB-BB Bond, launched in January 2011, focuses on corporate bonds in the crossover area rated BBB and BB. The ‘5Bs’ bond fund is actively managed against Lombard Odier’s fundamentally weighted index for corporate bonds.

At the end of March, LOIM managed 35.8 billion Swiss francs on behalf of clients, of which 13.6 billion francs was managed in fixed income strategies.

“These funds, which invest in European government bonds excluding the UK, move away from the traditional bond index approach, which gives a higher weighting to issuers according to the volume of their debt,” says Lombard Odier in a statement. Instead, “the funds are managed on a fundamentally weighted basis which assesses factors including the size of a country’s GDP and therefore its ability to repay debts.” The index also takes into account GDP growth since a faster-growing economy will generate more tax receipts to service its debts.

Stéphane Monier, chief investment officer of fixed income and currencies at LOIM, says: “With the creditworthiness of so many countries in the spotlight, it makes sense to invest in bonds from issuers most likely to pay their obligations rather than get further into debt. The fundamentally weighted approach is a sophisticated measure of an issuer’s ability to meet its obligations.”

“Bond investors are taking a sceptical look at the methodologies behind their benchmark allocations. Our approach is proving attractive with clients as demonstrated by the over $800 million invested in the Lombard Odier Emerging Local Currencies and Bond fund in just 14 months.”

The Lombard Odier fundamentally weighted index for sovereign debt looks at a number of factors, including macro-economic measures, forward-looking obligations on the issuer and socio-economic issues. Forward looking obligations include “assessing the public and private sector debt burden of a country, as well as the foreign net ownership of debt, since countries that receive a significant amount of funding from foreign investors are at risk of capital flight”. Similarly, countries with lax fiscal discipline and poor budgets have a lower weighting in the index because they will require more debt to fund deficits. Countries with current account surpluses are competitive in the global economy and receive a higher weighting. 

Socio-economic issues such as aging populations are a challenge for governments in the future and will impact health and pensions. Countries facing more difficult circumstances are allocated a lower weighting. In the same way, countries with higher political risk have a lower weighting since governments grappling with high inflation or unemployment, for example, will struggle to make significant economic changes.

The Lombard Odier fundamentally weighted index for corporate bonds uses a two-stage process. It first examines each industry sector’s contribution to GDP and then analyses each issuer according to turnover, leverage, interest, free cash flow and growth rate of earnings versus growth rate of debt. This is designed to provide a more stable and representative industry weighting and an investable universe of the most attractive corporate bonds. Such an approach would have helped to mitigate the late 1990s phenomenon of the telecoms sector occupying a disproportionate share of the high yield universe or helped limit investors’ exposure to financials going into the crisis in 2008. 

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