Today, as practitioners continue to navigate the structural shift to an inflationary, higher interest rate investment regime in a volatile, uncertain, complex and ambiguous world, it stands to reason that portfolio strategies must continue to evolve from what worked in the prior “lower for longer” regime. We must think through which portfolio construction strategies remain fit for purpose, which are no longer appropriate, and which new strategies should be adopted. But common wisdom also warns us against throwing the baby out with the bathwater. Prioritising the most important changes to make to investment objectives, asset allocation, currency management, manager selection and blending, and risk management is key – because you can do anything, just not everything!
We are at a critical turning point in human history as developments in the field of artificial intelligence revolutionise the ways in which people work, learn and play – to the same extent that the printing press, steam engines, electrification, telephones, television, computing and the internet changed the world. While the integration of AI promises radical productivity improvements across a range of activities, concerns are growing that such technologies will exacerbate social inequality, the spread of misinformation, and financial volatility, to name just a few. And then there is the “known unknown” risk of so-called singularity in which AI surpasses human intelligence.
Some 20 years ago, the Forum stood out from the crowd by arguing that the “Turbo of Technology” was one of five megatrends that would shape portfolio construction for decades to come. It’s hard to remember, but Google was just a baby! But it seems we ain’t seen nothing yet. Not only has the Turbo of Technology arrived, a ludicrous exponential curve is upon us. Technology is more than one of five Megatrends – it is THE megatrend! Investment fund managers, service providers and practitioners must understand the risks and opportunities associated with the unfolding evolution of technology and AI, and take specific action relevant to multi-asset, multi-manager investment portfolio construction. Doing nothing is not an option!
Three gigantic, global, interconnected risks have the potential to upend the world as we know it. Investors who understand these will be better positioned to successfully navigate the uncertainty plaguing our world.
In the same way that Moneyball has swept every professional sport, data science is bringing greater transparency to portfolio managers' decision-making skill. To select managers capable of outperforming, behavioural analysis is crucial.
At a time when "you can do anything", there are meaningful implications and opportunities for portfolio rebalancing and investors still structurally underweight bonds need to put aside recency bias and "do something" - now.
Many financial commentators have suggested that the strong growth of the non‐bank corporate lending market is a short‐term, cyclical trend that could threaten the stability of our financial system. The growth of the non‐bank market can be explained by a long‐term structural shift toward private capital as banks and public markets have transitioned from serving small and medium‐sized companies to larger companies over the past several decades. For investors, private credit presents an attractive opportunity to add diversification and attractive risk-adjusted returns portfolios. Characteristics such as yield premium over comparable liquid markets, control, upfront economics and low historical volatility and default rates all make this asset class one to consider for a core allocation in investors’ portfolios.
The market and economic backdrop is making diversification in a global equity allocation difficult. Market cap indices are narrower than any time in history, as the market and active managers flock to the mega caps perceived as logical winners from the AI revolution. As markets become narrow and expensive, core, growth and quality portfolios are converging. This presents risks for many portfolios but a great opportunity for valuation-focused investors. While headline multiples are demanding, there remains opportunities in predictable earnings and forecastable cashflow generators that are being overlooked. As valuation and concentration risks rise, doing nothing is no longer an option, particularly when not everything carries the same risks.
Every day, every one of us is touched by infrastructure and, the longer we live, the more billions of us there are, and the more we need infrastructure. Driven by a number of macro themes, over the next 17 years to 2040, experts predict we need to invest US$94 trillion in infrastructure just to keep pace with our human needs. This investment has benefits to people and communities everywhere. Demand for essential infrastructure offers opportunities for investors to generate a steady reliable income with inflation protection built in and includes mitigants to a rising interest rate environment. In today’s world of uncertainty and volatility, one thing that is certain is the ‘essential’ role infrastructure plays in investment portfolios. If you do anything, include infrastructure in portfolios.
While global markets in 2023 have been led by a narrow group of mega-cap stocks, global small caps may be rewarded by the markets going forward supported by faster expected earnings growth and compelling valuations relative to large cap equities. The size and dynamism of the universe allows managers to identify a broad array of small cap companies across geographies and industries with improving company fundamentals and scope for multiple expansion. Stock selection and prudent portfolio diversification, however, are critical as investing in small caps translates to both greater opportunity and risk.
Opinions about private markets are often not rooted in facts, due in part to the fact that data on private markets has been scarce. But data is available and it debunks some of the common misconceptions about private markets.
The unique characteristics of private debt make it ideal for any portfolio. It is a versatile asset class that fits in either the defensive or growth component of an investment strategy – or even both at the same time. It can provide a strong hedge against inflation, increase a portfolio’s total return and decrease overall risk. Funds that hold lower risk positions in senior secured or investment grade debt may be a suitable alternative to traditional bonds. Alternatively, funds with exposure to sub-investment grade debt or alternative parts of the capital structure can replace part of an allocation to equities. Either way, private debt’s low correlation with other asset classes means it really can give investors just about everything across a full economic cycle.
Warren Buffett famously said, “in the short run the stock market is a voting machine but in the long run it is a weighing machine” - what gets weighed are fundamentals, specifically earnings. Brokers hire a great many analysts to write and publish detailed analysis on corporate earnings forecasts. These individual forecasts are combined to create consensus median estimates on what a company is expected to earn in 12 months’ time. It’s right to focus on earnings, but the level of delivered growth is less important than the surprise in growth, the amount by which a company beats or disappoints relative to expectations. Equity factors focused on fundamentals deliver better outcomes - and given the uncertainty in the current environment, the Quality and Low Volatility factors can capture better earnings surprise when the overall market disappoints, providing protection in an equity allocation.
The transition a net zero emission economy offers risks and opportunities for investors. Investors are increasingly seeking to invest in the resource companies and manufacturers whose products are required to enable the world to transition to cleaner energy sources while avoiding businesses with high emissions, due to concerns about asset stranding risk. Infrastructure companies provide access to energy, water and transport - as they always have done - and are generally not viewed as exciting energy transition opportunities. Furthermore, infrastructure screens as high emissions. However, infrastructure sectors are major beneficiaries of the transition and concerns about asset stranding risk are misplaced. Infrastructure is a simple way to benefit from the transition to a net zero emission economy and represents a multi-decade growth opportunity.
Emerging Market (EM) equities continue to trade at significant discounts to those in Developed Markets (DM). With structural demographic tailwinds, years of relatively progressive interest rate policies and major progress on the ESG front, most EM economies (at least those with a reliable rule of law) are well placed to deliver positive outcomes for investors. Today, many of the leading companies servicing those economies have superior earnings growth to their DM peers with many trading even cheaper than at the height of the Covid market turmoil. Are valuation driven investors breaching their own defensible investment philosophy by not holding a standalone exposure to EM equities?
Further weakening of the global economy continues to be likely with geopolitical, policy and banking sector pressures and the elevated probability of recession in coming quarters. Sitting on the sidelines with cash, however, comes at opportunity costs to investors with current yields at a decade high. The role of bonds in a portfolio can aid in pursuing investor goals or stabilising a portfolio to be more resilient when economic shocks hit markets, however, many investors would benefit from evaluating whether their bond holdings are meeting these goals. Investment-grade corporate bonds offers an important ballast towards overall asset allocation and can improve portfolio risk-adjusted returns. A focus on the highest quality securities will provide opportunities for investors to capture future income, as well as add a defensive anchor within portfolios.
Private Equity funds are impressive and have great marketing. It would be great if we could "invest in everything", but that is not feasible. Fund selection has massive alpha potential, but it is hard, and only ever investing in top quartile funds over time is virtually impossible. Private Equity pooled returns (weighted average) have historically been attractive, while also less volatile than investing in a single fund or fund-of-funds. A lower cost, efficient and scalable approach to investing, effectively allowing investors to "buy the private market" would be easier and better. An investible index of private market funds would deliver this and complement investors' portfolios in many ways, just like in public markets.
The median Australian small cap manager has outperformed the ASX Small Ordinaries consistently over the long term. Persistent operational and valuation leverage along with differentiated investment approaches creates this ongoing alpha opportunity. Small Caps have underperformed large cap peers in recent times however cyclical factors today and a rebound in domestic risk sets up for the reemergence in Australian Smalls.
Why does our industry exist, why do we as industry professionals get up in the morning, how often do you speak with your clients, what about the actual end-client? As professionals we need to stand with our clients and share our voice to ensure risk-aware approaches – and the ability to provide security to our clients’ investment journeys – remains part of our investment landscape. We must whole-heartedly embrace risk AND return multi-asset portfolio construction.
The Investing Roundtable explores key challenges and opportunities in multi-asset, multi-manager portfolio construction that practitioners should be thinking about, given they can do anything, but not everything! Our research analysts will each articulate a challenge or opportunity related to researching and identifying quality investment management solutions that they believe portfolio construction practitioners should be thinking about when building quality multi-asset, multi-manager portfolios.
The young are better able to navigate volatility, uncertainty, complexity and ambiguity, owing to their natural growth and learning mindset. In an environment where investors can do anything, just not everything, we can all benefit from adopting a youth mindset. Young people own their values, are passionate in their activism, use empathy to understand the world, and seek clarity and choices that allow them to be agile and adaptable. Practitioners can incorporate these lessons to successfully navigate a VUCA world, and build better quality multi-asset, multi-manager portfolios for their clients.