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.
Options under-utilised for portfolio protection
Investors who have enjoyed the rewards from two strong years of equities performance may now be thinking it’s time to lock in the gains. How do you do that? Towers Watson says options should be used more extensively.
In its annual ‘Global Investment Matters’ series of articles published last week, Towers Watson says investors who wish to reduce investment risk face the choice of buying bonds, diversifying into alternatives or purchasing insurance against market falls. But bond yields are still at record lows and investors have already poured significant sums into diversifying asset classes, pushing up prices.
“We generally believe that a combination of strategies is better at meeting objectives than any single strategy in isolation. However, to date most institutional investors have not used options,” Towers Watson says.
“Partly this has been a reflection of their perceived cost, but has also been a reflection of the large number of choices with which users of options are faced.”
For instance, one of the drawbacks of options strategies is that they have to be rolled over and therefore their appropriateness constantly reviewed.
But Towers Watson says: “We are now starting to see increased interest in options as pricing has become more favourable. We are also hopeful that a greater focus on standard benchmark strategies will
 lead to less choice and more options.”
In a separate article, the consulting firm says that institutional investors can learn from corporations to make themselves more nimble and therefore better able to address things such as market reviews for options strategies.
Market conditions regularly drive companies to re-assess their strategy and reposition themselves organizationally.
“Asset owners, too, face pressures to adapt to a changing environment. Can they look to corporate counterparts and learn how to be more flexible, nimble and prepared to change?”
The article uses the example of Samsung, which 20 years ago was a high-volume, low-quality manufacturer whose brand was barely known outside of Korea. Today it is the world’s largest electronics company by revenue. That transformation is largely attributed to the company’s chairman who once famously said: “Change everything but your wife and children”.
