The five key elements of Parmenion Ethical’s investment approach are:
- Fairness (the condition sine qua non in our DNA)
- Asset Allocation
- Manager Selection (active managers who try to outperform their benchmark & peer group, and – if necessary – passive solution components)
- Active Risk Management
The Parmenion Ethical investment approach; creating best-of-breed portfolios based on Fairness
It all starts with the Parmenion Ethical Fairness ‘equation’ as first layer: every aspect in our solutions has to comply with the double filter of UN-PRI- and Shariah-compliance.
We create our ‘top-down’ solutions using the famous, proprietary Markowitz-Van Dijk asset allocation concept of Parmenion Group (see also below). This delivers a smart allocation over asset classes, regions, countries and industrial sectors that according to us holds an optimal probability to outperform the relevant benchmark and peer group.
Notwithstanding the fact that our systems encompass more than 100 countries, half a dozen asset classes and more than a dozen industrial sectors plus quantitative factor models that screen and evaluate 15-20 variables for each investment we consider, we remain humble. Or maybe we should say: because of that. And adding in all cases a qualitative layer to our analyses, through which we also incorporate specialist analyses by our own and external advisors/analysts (and academic and professional research reports), doesn’t change much either.
We remain humble: it is possible to outperform, but it is not easy.
And the risk of overestimating abilities is always there.
That is why we diversify between best-of-breed specialists.
Diversification is therefore at this stage an equally-important aspect of our approach. And not surprisingly so. Parmenion CIO Erik L. van Dijk has collaborated closely with dr Harry Markowitz, whose Modern Portfolio Theory was basically showing that ‘’Diversification as risk management tool is the only truly free lunch in finance.’’
We then proceed to find ‘best-of-breed’ active investment managers that would give us the best possible exposure to the mix of countries, regions, asset classes, sectors derived during the asset allocation and diversification stage. Parmenion Ethical is totally independent, and the entry and exit rules that we created for incorporation of managers into our solutions are well-defined, stringent and transparent. In case a manager is disappointing, it is not that hard for us to replace him/her by a better alternative.
We will only select the active strategy, when the expected excess return vis-à-vis the relevant benchmark index exceeds 2 times the management fee differential. If not, we will opt for a cheaper passive (through the use of exchange-traded funds) solution instead.
We will build portfolios that invest mainly with the specialist grandmasters of Fair Finance. And when completion is needed, either because the right grandmaster cannot be found, or due to risk management considerations, we will do so in as cheap as possible a way using passive components (conditional on them complying also with our ethical constraints).
Active Risk Management
At Parmenion Group we actively manage Investment Risk. We do so, not to avoid risk in general, because that would also leave us with low investment returns, but so as to avoid unrewarded risks that do not translate into extra returns.
Although we do not believe that history will repeat itself time and again, we do agree with Mark Twain who once added that ‘although this may be true, history has a more than decent rhyme!’ We have incorporated this ‘rhyme of history’ in three different ways within the quantitative component of our active risk management system.
Historical Indicators within the Quantitative Component of our Active Risk Management System
- The ‘Classics’
Volatility, Beta and Correlation are calculated using a 36-month interval. When there are no monthly prices available we will use a proprietary system for the derivation of proxies. We also apply both the absolute risk level and trend patterns in our analyses.
- Stress Test
The behavior of asset or asset class returns during the biggest crises of the last 50 years is analysed in detail. Investments in the bottom tertile in terms of negative sensitivity will be vetoed. Allocations to investments in the top tertile will go through as recommended by the investment team. Allocations in the second tertile can be adjusted downward by up to 50% by Parmenion’s Investment Policy Committee (IPC).
- Nicanor Bankruptcy Prediction Model
The proprietary Bankruptcy Prediction Model of Group company Nicanor will be used. This provides an indication of a company’s fundamental quality. Investments in the bottom tertile in terms of prediction model scores are vetoed.
Next to these three more historical quantitative risk indicators, our team is also convinced of the added value and forecasting qualities of the VIX score and implied volatility levels of relevant option series.
Behavioral Economics has taught us that market participants as a group react in a flawed way, especially when these indicators reach extreme levels. Periods of extremely low values of VIX and implied option volatility are characterized by investor lethargy: investments in risky assets should be avoided or at least reduced.
Periods of extremely high values of VIX and implied option volatility are caused by investor overreaction: unless one believes that the end of the world as we know it is near, investment in risky assets should be increased. But risk is not just quantitative risk at Parmenion Ethical.
Under the guidance of the Chief Risk Officer (CRO) the investment team will undertake a thorough due diligence procedure in which operational, legal, management, governance and regulatory issues are carefully studied.
One or more face-to-face meetings with representatives of the investment target will be part of the procedure. In this phase the CRO can veto specific investment propositions.
The active risk management does not stop when investments are made. Ongoing monitoring will take place, and this could translate into a sell-off later on. During the holding period of the investments the risk management team will also try to enhance the net investment returns – if applicable – through an active risk mitigation strategy in which the negative impact of adverse market or currency sentiment will be isolated.