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.
Thriving in a new market environment means getting agile: Colonial First State
Grit is being thrown into the machinery of global trade by economic protectionism and the switch from just-in-time manufacturing to just-in-case. Inflation data will remain volatile – and this year’s expected rate cuts are a shakier prospect – while the benign geopolitical backdrop has collapsed, revealing the façade it always was.
It all adds up to a completely different market environment than that which has prevailed over the last 40-odd years, says Colonial First State CIO Jonathan Armitage, and investors will need to become more “agile” to cope with it.
“(That means) focussing on where your overall equity weightings are, how much of your global portfolio is hedged versus unhedged, understanding the duration of different parts of your fixed income portfolios and the factors that are driving equity performance,” Armitage says, “and perhaps being more flexible about the way you manage those factors over the next two to three years, which you can do by shifting the weighting around between individual portfolio building blocks or managing exposures synthetically… I think it’s that adaptability that will be an important factor going forward in making sure we produce robust returns for our members.”
While US tech equities played a significant role in nearly every funds’ FY2024 return (CFS returned 12.1 per cent in its MySuper product), Armitage says that there’s been a broadening out of performance in the CFS portfolio over the last four or five months; strong numbers are coming through from healthcare, and, in European equities, the luxury goods sector, while the fund also reaped robust returns from domestic commodities companies and the likes of Goodman Group, which has benefitted from surging interest in data centres. The “bookends” of the equity markets are tech – and not just US tech, with the chipmakers across Asia – and, from a valuation perspective, China and the UK.
“You’re almost running out of people to sell UK equities to,” Armitage says. “I think we’ve gotten used to putting global equities into one bucket, and the valuation arguments – both geographical and by sector – have become quite stark. And it’s about understanding what’s driving those and how sustainable they are and whether or not there are some opportunities from a valuation perspective that can be exploited.”
CFS has mostly steered clear of unlisted assets, though Armitage has in the past talked about the possibility of picking up some at a discount. But the downturn occurring in some unlisted property subsectors – a result of not just a negative financial backdrop but changes to the way people work and the things they want when they actually are in the office – shows no signs of abating.
“It’s been playing out not just in terms of the decline of valuations that has been widely reported, but these other headwinds that are going to continue for some time – particularly if interest rates remain elevated… those legacy assets are going to be quite challenged, and they’re expensive to redevelop.”
But in the new market environment Armitage is eyeing, it seems possible that – at some point – the malaise might not be confined solely to commercial property.
“This different operating environment presents its own challenges, and those are my primary focus. We’ve talked about areas like private debt and we’re going to continue to build out our exposure there, further diversify some of our exposures in fixed income, and selectively continue to look at making investments in, primarily, unlisted infrastructure. But I think we’ve got a portfolio that’s structured in such a way that we can take advantage of some interesting investment opportunities as and when they arise.”
