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.
Appetite for diversifying strategies drops
Multi-asset managers are cutting exposure to equities despite improving risk sentiment and opting for patience when it comes to making major changes to their portfolios, according to data from bfinance. The data, gleaned from bfinance’s manager search database, also shows that – despite their stellar performance through 2022 – interest in diversifying strategies has actually gone backwards.
“Interestingly, manager search activity targeting ‘diversifying strategies’ dropped in 2022 (ed: diversifying strategies represent 11 per cent of searches). Although the decrease was slight, it may be considered surprising given the general consensus that investors are seeking to improve portfolio diversification. Within this group, we note a particularly sharp decline in hedge fund mandates.”
“Although divergent and convex hedge fund strategies such as CTAs and global macro have had an outstanding year, many investors may feel as if they have ‘missed the boat’ on those returns. Among private markets manager searches, private debt and private equity led the pack in 2022, knocking real estate into third place. Despite the strong appetite among bfinance clients, we note an overall decline in industry fundraising across private markets.”
Private equity manager search activity rose “significantly”, with the asset class accounting for 25 per cent of all private market searches – up 11 per cent compared to the previous 12 months. But as bfinance notes, that runs contrary to the overall fundraising trend, suggesting institutional investors might just be window-shopping while they try and get their portfolios back in order.
“Investors continue to tackle the challenge of the ‘denominator effect’: some clients deciding to press pause or reduce the size of certain private market commitments in view of depressed public market portfolios; others are keen to maintain vintage diversification and anticipate that imbalances will be corrected with time. Although public markets showed some signs of recovery in Q4, the denominator challenge continues to affect investors in 2023.”
But private debt retained its crown as the most popular asset class in private market manager selection, accounting for 28 per cent of all manager searches as investors look for floating rate exposure.
“Globally, private debt remains the most popular asset class,” said Sebastian Mays (picture at top), business development director at bfinance in Australia. “In Australia we see ongoing demand from investors for the many facets of private debt. This is likely due to the floating rate nature of the asset class and continued attractive risk return profile.”
In normal times, an improvement in risk sentiment would see a shift in favour of equities and at the expense of fixed income. But these aren’t “normal times”, and multi-asset managers cut their equity exposure to less than 28 per cent – the “lowest level since the GFC”.
“Recessionary fears, attractive fixed income valuations and expectations of an imminent peak in interest rates drew market participants back to bonds,” the report says. “… There are stronger signals that we are close to the peak in interest rates. This is evident, for example, in the futures implied rate, which corresponds to market expectations for the Federal funds rate.”
“This may, on the surface, appear positive for macroeconomic stability. Yet, as market attention moves away from inflation, investors turn to focus on recession: corporate earnings are experiencing downward revisions of a magnitude not seen since the recessions of 2008 and 2000.”
