What actually delivers performance?
A portfolio’s asset allocation is the key determinant of portfolio outcomes and the main driver of portfolio risk and return. Ensuring the asset allocation is aligned to an appropriate objective is therefore key. Getting and keeping the asset allocation on track for the given objectives and constraints is how portfolio managers can add most value for their clients.
What differentiates portfolio managers?
There are no “secrets” to asset allocation in portfolio management. It is perhaps one of the most well-studied and researched fields of finance.
Perhaps unusually for a competitive service industry, core know-how is not a barrier to entry. Anyone completing their Chartered Financial Analyst exam will have a comprehensive grounding in the principles of portfolio management.
There are, in my view, three differentiating factors for discretionary fund managers.
Quality of Process
To create a quality investment process, managers need a robust set of capital market assumptions for each asset class and the relationship between asset classes. Ideally these should be term-dependent, to align to an appropriate term-dependent investment objective.
To create an appropriate asset allocation, managers need to consider what their objective is: is it risk-adjusted returns in which an asset-optimised approach makes sense (the bulk of retail multi-asset strategies take this approach); is it to match future liabilities, in which case a liability-relative approach makes sense (more akin to how a defined benefit pension scheme is managed); is to target a volatility level or band; or is to target a level of income distribution.
Managers also need to design a set of constraints – risk budget, fee budget, minimum and maximum position sizes, portfolio turnover constraints and counterparty considerations.
Managers need to make implementation decisions as regards how they access particular asset classes or exposures – with direct securities, higher cost active/non-index funds, or lower cost passive/index funds and ETFs. Fund level due diligence as regards underlying holdings, concentrations, round-trip dealing costs and internal and external fund liquidity profiles are key in this respect.
Quality of People
Whilst we believe strongly in the deployment of technology to assist managers in designing, building and managing portfolios, that doesn’t mean that people aren’t core to a business. Investment managers must invest in their people to build on both quantitative skills that are necessary to finance as well as communication skills that are necessary to communicate with advisers and their clients. It’s people that make up a brand, and clients measure performance as much on client service as on returns.
Quality of Proposition
There are few firms, if any, that can build an end-to-end proposition entirely in-house. Part of a manager’s skillset is to understand where their expertise lies. We believe that there is little value in reinventing the various wheels of a proposition. But there is tremendous value in bringing together best in class components that create a proposition in a way that is robust, repeatable and proprietary.
It’s the quality of choices around proposition that differentiate portfolio managers, and in this respect it is important to remain agile and adaptive, to a rapidly changing landscape in asset management and technology.
Bringing it all together
The objective for investment managers is no longer about “pushing” one product or another. It should be about providing solutions that help address a specific need.
Managers should ask themselves: what problem is the investment strategy trying to solve for their client? How can they do that in a way that is robust, repeatable and evidence-based, so that everyone can sleep well at night?
The secret is, there are no secrets. Good portfolio management is about focusing on what matters, using informed common sense.
ETF Investment Strategy