Édouard Carmignac: all-time great or one-hit wonder? (co-written with Steven Goldin of Parala Capital)

This essay appeared in Citywire Wealth Manager on September 16, 2014.

 

When it comes to evaluating a fund manager’s skill, performance numbers only give you part of the picture; it is crucial to also focus on the drivers of that track record.

Our analysis suggests that a manager’s returns are often as much a result of the environment in which he is investing as his investment skills. What often makes a manager stand out is his or her ability to read the broader economic scenario correctly.

With this in mind, a key question for a fund investor is: does the manager have the ability to continue producing strong performance as the investment environment evolves?

This line of thinking is particularly important when two conditions are present:

Financial markets are going through major shifts – either positive or negative.
The manager and fund in question have massively out/underperformed the market and its peers.

Credit crunch star

During the global financial crisis of 2008-2009, few fund managers exemplified investment excellence more than Édouard Carmignac. With the courage to take a contrarian view, he positioned the now famous Patrimoine fund against the prevailing winds of the market and waited – he could see the wreckage that lay ahead.

The oncoming credit crisis produced a sharp rise in default spreads and dividend yields, along with a fall in short rates as governments tried to keep the financial system functioning by flooding it with cheap money. For those money managers that understood how these macro-economic events would play out, it was an opportunity to deliver substantial outperformance.

Turning to Carmignac’s Patrimoine fund, the charts on the right show its changing sensitivity to evolving macro-economic conditions and the estimated alpha derived from its positioning and related exposures.

Over time, big movements in major macro factors are reflected in changes to the state of the economy. By picking up on key trends such as the default spread, we can see that Carmignac changed his fund’s positioning prior to the onset of the credit crisis and profited handsomely.

As figure 1. shows on the righthand side, Carmignac dramatically increased his fund’s sensitivity to the default spread before the onset of the credit crisis (green line, right-hand axis) which generated substantial alpha (blue line) as default spreads expanded hugely.

In this way, Carmignac avoided exposing his fund to much of the market’s toxicity. Few recognise that this defensive position was not an overnight idea but the result of a long-term view developed over a period of years – it stood out against the prevailing view of most funds before the crisis. By remaining exposed to high quality and limiting exposure to credit and its risks, he was able to outperform the market and his peers in style.

Fig 1

Fig 2

Man of the moment

Carmignac is arguably the single most important fund personality over the last few years, if only for putting flexible funds back on investors’ radars. For this reason alone, he has made a tremendous contribution to future of the industry. What lies ahead for investors in his funds is a more difficult matter to assess.

Carmignac’s shrewd decisions during the perfect storm for markets in 2008-2009 proved to be the makings of a blockbuster fund par excellence. But is that exceptional decision-making ability sustainable? What is the next great idea? What will drive Patrimoine’s returns into the future?

The fund’s performance in relation to the default spread over 10 years shows something quite interesting. We see that what made the Patrimoine fund such a standout was its positioning prior to the onset of the credit crisis which provided optimal macro-economic exposures for the state of the economy during that period.

In academic speak one would say that it was the nexus of timing-varying skill meeting a time-varying opportunity which made Carmignac and the Patrimoine fund such stars. However, for reasons we are now considering, the manager did not adapt his macro exposures to navigate the changing economic conditions which followed. This has weighed heavily on the fund’s performance between 2010 and 2014.

For his prescience, Carmignac and his eponymous firm were well rewarded. Investors, having only seen red in the results columns of other funds, responded by diverting their money his way.

Since 2009, Carmignac has grown into a European powerhouse. Assets have flooded into the organisation, products have proliferated, personnel (and some might say personality) has expanded immensely.

More recent investors in the Patrimoine fund have high hopes. Past performance is the single strongest psychological anchor for investors setting expectations for the future.

This is reinforced by the cult of personality inspired by star managers. When reviewing the performance of Patrimoine, we must recognise that the vast majority of assets under management did not enjoy the strong performance run that made Carmignac famous. It is hopeful money after the event.

Enduring skill or one-trick pony?

The macro analysis we have discussed is one possible explanation for why Carmignac has found it challenging to repeat the stellar performance of 2007 and 2008.

His prescient skills pre-credit crisis combined with the singular nature of the crisis itself to drive his fund way ahead of the pack. However, sticking to his guns during the changing economic conditions that followed has taken its toll.

Note the amazing performance of the fund relative to appropriate benchmarks in 2007 and 2008 and how the subsequent poorer macro positioning may have contributed to the underperformance in 2010-2014 – see table below (2014 performance stats are until end of March).

Fig 3

So, was Carmignac’s performance and the related interest in his firm the result of an unrepeatable phenomenon – a one-hit wonder?

The Rolling Stones, the rock n’ roll model of longevity, famously played at a Carmignac company event in 2012. If asked 25 years ago, most people would not have expected the group to still be performing at superstar levels. Perhaps the same applies to Carmignac.

Most blockbuster funds develop because a manager is well-positioned to capture a market trend with a strong performing fund. Over the last 20 years trends in demand for income, absolute return, BRIC, commodities, etc. have all been root drivers of the initial stages of such success stories.

Investors must learn to gauge whether exceptional performance over short to intermediate periods may be due to one-off, event-driven occurrences. The credit crunch of 2008-2009 was perhaps a once-in-a-generation opportunity.

However, the frequency of such events is more common than many statistical models would suggest. There is likely to be at least one fund manager well positioned for the next one – the trick is to find that forward-thinking individual just before it arrives.