Since the emergence of “Modern Portfolio Theory” and the “Capital Asset Pricing Model” in the late 1960s, institutional investors have taken a quantitatively driven approach to portfolio construction, looking to create portfolio diversification and obtain better risk-adjusted returns by balancing their asset-class exposures. This journey has seen several important advancements in thinking about how to optimally achieve desired results.
Funds that want to take the total portfolio approach first need to get the total portfolio view. To do that they not only need data – and lots of it – but a rock-solid understanding of exactly how they’re going to use it.
Hamish Douglass is hoping for rain
An ugly situation in markets could be just the thing Hamish Douglass needs to reverse the fortunes of Magellan. But there’s no telling what will happen when it arrives.
Hamish Douglass is hoping for rain – or really, the whole storm. He can’t guarantee that Magellan’s flagship global equities fund will do better in one, but there’s a strong chance that it will if anything he’s said over the last several years holds true. It’s calibrated to perform well in down markets but suffers when the news is good – as it has been, exceedingly, for about two years now.
Inflation and interest rate rises might change that. Indeed, Douglass even found himself uttering those fateful words: this time is different. The facts likely agree with him. Measured on “any realistic basis”, the valuation of equities relative to economic output is the highest it’s been in one hundred years and has jumped even further with the stimulus binge. Central banks are unlikely to rescue markets – as they’ve done nearly every other time – because they’re simply out of options.
“The game up scenario is the inflation issue. If truly inflation is persistent… and the Federal Reserve has to start tightening monetary policy materially faster than just a normalisation to stop persistent inflation, I really think we could be in a world of pain,” Douglass said on Thursday (February 3).
“We want to have businesses that inherently have pricing power in them and we want them to have low capital intensity so hopefully they can be growing their earnings in line with inflation,” Douglass said. “So you get a CPI index-linked bond; Yum Brands would be a wonderful thing, Visa and Mastercard. They’re royalties over what the world is, and less sensitive to interest rate rises. You want to be in things like SAP, that’s in transition to the cloud.”
The prospect of a major correction and a vastly different market paradigm for the foreseeable future holds the dark promise of a turnaround in Magellan’s fortunes, as it does for anybody who has predicted an end to the bull run and put their money where their mouth is. Douglass believes that Magellan is the “designated driver” at an increasingly wild party, and has previously said that he won’t start “chopping and changing” the portfolio in response to short-term underperformance.
There’s still plenty of risks out there. The true test will be how he deals with them. But Douglass still believes that Magellan’s target return of 9 per cent per annum will beat any long-term equity benchmark “over a long enough period of time.”
“We’re going to be affected; everybody’s going to be affected,” Douglass said. “As an equity investor, if we get a big jump in interest rates, I can’t promise that we’re going to go up and that other people are going to go down. That’s completely unrealistic. But I think that our portfolio is much higher quality and has much better attributes to deal with that world.”
Performance has suffered. Shareholders are angry. An institutional investor has headed for the exit, taking a near $20 billion mandate with it. Magellan’s share price fell sharply over the course of Douglass’ appearance. And so far, everything is going according to plan.
