The end of easy money, growing social and environmental dangers, and fast-changing market conditions are putting the pressure on investment returns. So how will tomorrow’s investment managers meet the demands of their clients?
John Bowman, CAIA
John Bowman, US-based director of CAIA, the global body for alternative investment education programs, is on the road in the Asia Pacific at the moment to discuss the changing world of asset allocation and the role of fiduciary advisers.
“I am here to talk about the rise of a new era, one where investors want to make sure they are getting the right return on their capital and fiduciaries need to work smarter to deliver investor outcomes,” he told AsianInvestor.
Bowman is meeting with limited partners (LP) and general partners (GP) in Singapore, Mumbai and Sydney to see how the ideas put forward in a paper produced by CAIA, entitled “The Portfolio of the Future” resonates with investors and managers.
CAIA’s data suggests that global investable assets reached $153 trillion at the end of 2020, with 12%, or $18 trillion allocated to alternatives. Meeting an 8% actuarial return at a pension, a 7% retirement return expectation for a family, or a 5% real spending rate at an endowment has not been a challenging hurdle.
The long period of cheap capital and easy money has catalysed innovation, created countless jobs, and provided a relentless tailwind for capital market returns, said the paper. In fact, a plain vanilla US-based 60/40 (equities/bonds) portfolio has compounded at more than 10% since 1980.
However, global strategists expect the 60/40 portfolio to return a meagre 3-4% in the next 10 years. Andrea Auerbach, global head of private investments at Cambridge Associates, said “investment professionals will have to look to differentiated sources of return, notably private capital, to increase the potential of being able to fully meet their obligations with responsible control of risk.
PRIVATE MARKET APPEAL
“Private capital has become increasingly attractive for earlier stage, new economy, and growth companies. Being detached from the short-term machinations of public markets, it liberates investors to take advantage of market dislocations, information asymmetry, and out-of-favour or countercyclical opportunities,” said Auerbach.
For example, state retirement fund NZ Super has approximately $757 million invested or committed to small, high-growth New Zealand businesses.
Katie Dean, NZ Super
Katie Dean, NZ Super’s internal portfolio manager for direct investments, points out the significant pool of smaller high-growth businesses in New Zealand that is constrained by a shortage of long-term funding and a lack of access to skilled investment management.
The fund targets transactions that are large enough to represent a meaningful addition to the fund: typically transactions of over $100 million to $200 million, where they acquire a 20% to 50% stake.
“Private markets are far from a silver bullet given their opacity, high fees, need for patience, and wide risk-return dispersion, and therefore must be carefully considered in light of client liquidity, income needs, and risk tolerance,” said CAIA’s Bowman. Extensive due diligence and thoughtful, deliberate manager selection is imperative, he said.
DISCARDING GENERIC MODELS
Another key challenge identified in the CAIA paper is the need to disentangle the various strands of investment advice and management.
Thinking Ahead Institute
Roger Urwin, global head of content at the Thinking Ahead Institute, said the investment profession “still has work to do in mitigating conflicts of interest, asymmetric payoffs, incentive dislocations between LPs and GPs, and unnecessary financial engineering.”
Expanding on how consultants and managers can implement future-proof portfolio ideas, CAIA suggests that “investors must evaluate all investment options and should not be limited by generic portfolio models. A holistic, purpose-driven portfolio is one that is not defined or limited by asset class “buckets,” but is customised to the client’s goals and outcomes.
Most institutional asset owners are sufficiently flexible to respond to exceptional market conditions. For example, GIC’s most recent portfolio report notes: “There will be rare occasions when GIC adjusts our Policy Portfolio’s asset allocation temporarily in response to medium-term dislocations in the global investment environment in particular assets or in countries.”
GIC manages and has characterised its risk preference using a reference portfolio of 65% global equities and 35% global bonds. NZ Super’s reference-portfolio asset split is more aggressive, at 80% global equities and 20% global bonds.
With such a strong weighting towards growth assets, the sell-off in equities this year has impacted the performance of the NZ Super fund, resulting in a annual return of -6.99% (to the end of June). However, as reported, its active investments have performed well relative to their benchmarks and have significantly reduced the drawdown of the actual portfolio relative to the reference portfolio.
POTENTIAL NEW PARADIGMS
Rather than relying on buckets of asset classes, CAIA suggests it may be more appropriate to think of a portfolio in terms of growth, yield and inflation protection. Integrating ESG should also be carried out in greater depth, said the association.
“Sustainability is not an overlay, it is a core component of the investment process. Approaching ESG as one element ignores the impact, importance, and even conflicts of the underlying components.
“Since ESG is an aggregate of tens, if not hundreds of factors, it’s important to focus on what is most material to an organisation. Taking a financial statement approach may be the best way to approach sustainability factors.
“Some issues will be easier to tie back to financial statements, such as stranded asset write-downs, while others will require a longer-term view of the company’s strategy and decision-making, such as diversity, equity, and inclusion.”
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