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.
‘Incoherence’ stops instos from investing for tomorrow: AustralianSuper, Stanford
Most big investors see the risks and opportunities of technological disruption (TD) but few have a plan to handle them, according to a new working paper from the Stanford Research Initiative on Long-Term Investing and AustralianSuper.
The paper, authored by Stanford researchers Ashby Monk and Dane Cook and AustralianSuper head of asset allocation Alistair Barker, says that the management of mass-scale TD – think the advent of the internet or generative AI – should be a priority for long-term investors (LTIs, the paper’s vernacular for investors varied and many as public pension funds, endowments, foundations, and sovereign wealth funds).
But LTIs face a number of small hurdles in their approach to TD, like disengaged leadership and lack of innovation in institutional investment organisations, that add up to the larger hurdle of “incoherent” management.
“TD strategies are unstructured, disjointed, and heterogenous,” the authors write. “Many LTIs exhibit a fragmented understanding of TD’s impacts on assets and markets and lack a unified strategy for organisational adaptation to TD challenges. Most LTIs rely on external managers for sourcing TD-related data and insights, and they hope that TD risks will be addressed “osmotically” thanks to networks, overseas offices, and relationships.
“The one thing that people should have been certain about when we were mass producing motor vehicles was that they should sell their horses.”
AustralianSuper’s Alistair Barker
Fragmentation of investment portfolios and investment teams means it can be difficult for a fund to manage TD risk without extensive communication and transparency (as well as a widely-held organisational belief that it does indeed present a risk). And while technological change can be blisteringly fast, it can also be glacially slow – and the amount of time and effort an investor is willing to spend on it is correlated with how immediate its impacts seem. Then there’s the fact that few LTIs have the sort of budget they need to deal with them.
“(These) are essentially identical to the hurdles that promote short-termism among LTIs in general,” the authors write. “We caution, however, that TD should not be construed as just another problem of myopia: it is a concern that goes beyond the difficulties LTIs face in reconciling short and long horizons. That said, we are aware (based on the decades-long struggle against LTI myopia, both in academic research and professional practice) that the foregoing hurdles are unlikely to be removed any time soon… if ever.”
But while it’s difficult to create a one-size-fits-all approach for the diverse investors that fit into the LTI definition, the authors advocate for a structured approach that prioritises an organisation-level perspective on TD analysis that filters down into portfolio-level responses.
“Unlike traditional market risks, the timeframe for TD is often longer and more uncertain, its impacts are unevenly distributed, and reliance on historical data is less effective,” the authors write. “This necessitates a proactive management stance – one that focuses on developing capabilities to identify, plan for, defend against, and capitalize on technological disruptions.”
Some stocks bound for the glue factory
The paper follows from comments that Barker made at last year’s AIST Superannuation Investment conference, where he warned that even sophisticated institutional investors would lose money to mass TD events.
“The one thing that people should have been certain about when we were mass producing motor vehicles was that they should sell their horses,” Barker said. “When we look at AI, it’s partly about the opportunity – and partly about finding out where the horses are… The one thing I’m certain about is that all our portfolios are filled with incumbent businesses in incumbent industries that could all be impacted.”
“On a dollar-weighted basis, the amount of money we have at risk from technological disruption is greater than the amount of money we have at risk to profit. The amount of money in Silicon Valley venture capital is one, perhaps two AustralianSupers. It’s not a very large industry; the profit potential for large investors is pretty small.”
