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.
Funds want an ‘evolution, not a revolution’ in alternatives
Two themes have dominated asset management flows over the last ten years. The first is passive,
which has become the workhorse equities solution for many large pension funds. The second is private markets. Nearly every major alternatives manager has seen record fundraising activity and been able to deploy that capital very efficiently, according to Ben Way, global head of asset management at Macquarie Asset Management – but the vast majority of that capital has not come from Australia.
Korean and Canadian funds have instead been much more active in the alternatives space, and there’s an “opportunity for super funds” to take a longer-term view and increase their exposure to private markets. But there’s also been an enormous amount of debate around popular thematics within private markets, which have been easier to invest in over the last ten years than they will likely be in the future.
“What I do think is if people are making a decision to have a greater allocation to private markets, not all managers are equal,” Way told the JANA Annual Conference last Thursday (September 15). “The last ten years has subdued the difference between managers and investment cultures, because it was relatively easy to raise capital and you had low interest rates and you had a very buoyant market to sell into. So from an alternates point of view, a lot of people could play a multiple leverage arbitrage game.”
“It didn’t mean those active managers were adding the value they said they would during the process. I think what we’ll find in the coming years is that asset managers who do have that ability to drive value during what is the largest part of any investment period – the hold period – will be able to differentiate themselves. If institutional investors are going to be more active in allocating capital to private managers, they have to be very careful with manager selection.”
Way has just returned from a whirlwind global tour encompassing Asia, the Middle East, and Europe, and has seen significant divergence in the strategies of pension funds throughout. Middle Eastern funds with young member bases and huge inflows “aren’t really interested in the investing cycle” – if they see something they like, they’re happy to buy and hold it for the next 10-15 years. Funds in European countries like the Netherlands are managing money for older members and have a greater need for yield – but they’re operating in the midst of energy and inflationary crises, and are much more cautious.
“Depending on where you are in the world, and depending on who your underlying clients are – the demographics of your particular market place, and what you’re seeing from a flows point of view – your outlook can be very long-term or it can be very short-term,” Way said. “Often that comes down to the near-term demands of your pension holders.”
Still, nearly every pension fund is worried about the same things – inflation, stagflation, geopolitics. But none of them are talking about any fundamental change to asset allocation, with many funds retaining their historical underweight to private markets and an overweight to more liquid investments. Given the way the world is going in terms of inflation and market volatility, Way said, there are institutions that need have a second look at their allocations.
“A lot of institutional investors like evolution rather than revolution, and I understand that because the job they do is incredibly important,” Way said. “For most of them they play a critical role in ensuring that people have the right payouts when they need their insurance or they provide pensions to individuals so they can live a secure, dignified life in retirement.”
“So from their point of view they need to get the balance right between evolving their allocation strategy and also being conscious about not making mistakes where they suddenly have a liquidity challenge or get into an asset class they don’t know particularly well. And they can select the wrong manager and then don’t deliver the right returns, so I certainly empathise with them.”
