OREANDA-NEWS. Fitch Ratings has affirmed LO Funds - Absolute Return Bond's (ARBF) 'Strong' Fund Quality Rating. The fund is managed by Lombard Odier Investment Managers (LOIM).

KEY RATING DRIVERS
The affirmation primarily reflects the fund's disciplined investment process characterised by a flexible risk allocation between diversified sources of returns within formalised risk limits. Performance relative to peers and objectives improved over the past 12 months to end- February 2016, as the fund demonstrated its ability to manage drawdowns and deliver returns uncorrelated with credit and rates cycles. Fitch therefore remains confident that the fund's investment process and resources support its ability to deliver consistently strong performance relative to peers over the longer term.

Fund Profile
ARBF is a sub-fund of LO Funds, Lombard Odier's Luxembourg SICAV which is UCITS IV- compliant. ARBF is a fixed income absolute return fund with EUR278m of assets as of end-February 2016. The current strategy was launched in July 2010. The fund aims to generate returns of 2%-3% in excess of its cash benchmark over a cycle with a target volatility of 5%. The fund invests both long and short, across developed and emerging markets, predominantly in cash bonds and derivatives.

Investment Process
The portfolio consists of a macro "structural" book to reflect the team's top-down medium- to long-term views, combined with three specialised sub-books that are run independently.

The fund's flexibility to dynamically allocate risk between alpha drivers is a key differentiator to peers. Risk budgets are allocated to each book, in terms of volatility limits and stop-loss limits (rolling over a range of time periods), and are monitored by LOIM's independent risk team to limit fund drawdowns.

Resources
Three portfolio managers (PMs) with an average of 20 years investment experience each run the fund. Gregor MacIntosh, lead PM and team head, actively manages the macro book (with its own risk budget) and allocates risk and capital to sub-portfolios. Each PM focuses on a specific book according to their skill sets and experience. Over the past two years, the emerging-market (EM) micro books were merged into existing books, after the departure of specialised EM PMs. The team have dedicated strategists to guide on macroeconomics.

The fund is supported by LOIM's infrastructure, notably two independent investment risk managers specifically involved in this fund and by LOIM's central functions. The platform is linked to Bloomberg (AIM), the fund's core front office system used for portfolio monitoring and trading.

Track Record
The fund outperformed its peers over five years and one year but underperformed over three years to end February 2016. The fund fell short of its performance objective since launch. Short credit positioning hurt performance in 2013 and 2014 but has more recently contributed positively. The fund's returns do not show correlation with credit markets, like many other fixed-income AR peers. The fund also tends to show lower drawdowns and smoother returns than peers.

Asset Manager
LOIM is the asset management division of the Swiss private bank Lombard Odier SCA (AA-/Stable/F1+). LOIM managed EUR44.5bn at end-December 2015, including EUR4.1bn in absolute return strategies. The infrastructure is well-suited to the investment process.

RATING SENSITIVITIES
The rating may be sensitive to material changes in the investment or operational processes, or resources dedicated to the fund. A material adverse deviation from Fitch's guidelines for any key rating driver could result in a downgrade. For example, this may be manifested in a structural deterioration in the fund's performance as measured by drawdown, excessive volatility or underperformance relative to objectives and peers. Departure of one of the three PMs may also cause the rating to be placed "Under Review" or downgraded. After a fairly poor 2013 and 2014, deterioration in the fund's performance compared with its objectives and peers would put downward pressure on the fund's rating.

Fitch currently sees limited potential for a positive rating action due to the fund's already high rating. However, an upgrade could be considered if the fund demonstrates consistent outperformance relative to peers and objectives over the long term. Nevertheless, this will be difficult to achieve given the poor performance of the fund in 2013 and 2014 and the gap between the fund's performance and its target.