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.
Alpha awaits in activist strategies: Frontier
It’s a truth universally acknowledged that equity market returns are likely to be muted going forward. But salvation might arrive in the form of domestic activist strategies.
“From a timing perspective, we think the forward-looking environment presents a much more challenging return outlook for equity investors given the extended low interest rate and bull market environment that has persisted for large-cap growth stocks until more recently,” write Frontier’s James Gunn and Fraser Murray and “Opportunistic ideas for a challenging return outlook”, the latest from the Frontier line.
“The implication is that investors may not be able to rely so heavily on headline equity market returns (i.e. beta), hence an increasingly important role for index agnostic, opportunistic strategies delivering less correlated source of alpha/return in domestic equities, global developed and emerging markets.”
Gunn and Murray believe that the same is true for big super funds, even with the Your Future Your Super (YFYS) performance test nipping at their heels. As has been remarked endlessly elsewhere, many of the funds that are at will likely move closer to the benchmark and away from riskier strategies due to the existential threat posed by failure.
“However, our view is that it is even more critical for super funds (given YFYS) to ensure they are deploying their active risk and fee budget in the most efficient means as it relates to portfolio return enhancement and diversification, albeit consistent with their specific tolerance for high active risk strategies and the associated fee load, additional monitoring/complexity and capacity constraints,” Gunn and Murray write.
The main thrust of their research concerns the opportunity in China A-shares; many super funds and other institutions are now exploring the opportunity set in Australia’s largest trading partner even as geopolitical tensions call into question the future viability of the region. Gunn and Murray believe the key appeal here is the inefficiency created by high levels of retail trading and the significant liquidity on-hand, while access opportunities for foreign investors and the instruments available for hedging are also increasing.
But Frontier is also taking a closer look at domestic-focused activist strategies. They’ve not been as popular in Australia as in other sophisticated markets despite a “highly conducive regulatory landscape” encouraging productive engagement, but Frontier anticipates that more institutional-quality activist-focused strategies will soon come to market, including those of offshore managers.
“Similar value-adding engagement objectives are pursued through mainstream equity managers (often with significant effect in small-caps),” Gunn and Murray write. “However in our view, exposure to an activist-focused strategy provides a more targeted approach through a typically concentrated number of investments, deeper research conducted on these concentrated holdings and with the potential for higher, less correlated portfolio returns.”
As always, manager selection will be key, and it’s likely not for the faint of heart: high tracking error will add to YFYS risk, while the profile and engagement style of some forms of activism – or specific escalations – might not align with the long-term approach of some super funds.
“The primary focus of these strategies in an ESG context is the “G”, but we also see a material opportunity for environmentally and socially-focused impact engagement in an Australian context,”
Gunn and Murray write. “We’ve seen in the US how activist hedge funds (in collaboration with the voting power and voice of index providers and pension funds) have delivered unprecedented climate-focused outcomes – for example, the Exxon board upheaval.”
“An activist strategy focused primarily on large and mid-cap ideas is likely to be a more scalable and relevant Australian equities niche for larger and growing asset owners compared to less liquid and capacity-constrained return-enhancing strategies like micro-caps.”
