In a highly interconnected world, the best investment portfolios will be constructed from the best companies, themes and funds from around the world. However, translating economic views and opportunities into individual portfolios is a challenge when there are so many moving parts and many financial organisations themselves are mammoth.
Each client portfolio will usually be the result of a structured investment process, where the wealth manager’s main views on markets, currencies, regions and risks are discussed and bundled in a holistic view. Most advisers are agreed that a portfolio full of stand-alone decisions will never be able to create robust and sustainable returns. The starting point will usually be the allocation decisions taken by the global investment committee, followed by an engineering and structuring phase, where these views are translated into concrete investments.
However, no system is perfect. Take for instance the global investment committee, which is tasked with discussing and distilling the collective knowledge of the group’s analysts and managers. BNY Mellon Wealth Management uses a system it calls Judgment with Quantitative Discipline to check any such resulting decisions against quant-based valuation models. “Having chaired many investment meetings, it can be dangerous when asset class managers fall in love with their own asset class and so the quant basis is there to ask proper questions,” says Leo Grohowski, chief investment officer at BNY Mellon Wealth Management.
“It is so easy to have a global markets strategy committee where the strongest personality, or the most articulate presenter, influences the outcome. That’s a concern around a purely judgmental process. The same people get together and talk about the same asset class and you get to a point where they can finish each others’ sentences. We like to rotate fresh eyes and ears through our investment committees for six-month periods to guard against ‘Group Think’, taking advantage of the 250 portfolio managers we have here.”
A huge organisation with an army of analysts worldwide can find it hard to harness the depth of expertise, while a slimmer house may be able to implement its view more quickly. “I’ve seen from personal experience the difficulties of regional analyst platforms,” says Tim Heffer, institutional business development at Skagen Funds.
“The communications effort rises fast, especially as it will involve different cultures and different timezones, and what analysts say and how they say it will be very different, with varying degrees of emphasis, so that converting it into a standard message is a real challenge.”
This is exacerbated by the market’s growing propensity to move in extreme and contradictory ways. Volatility is often perceived to be negative but of course it also stands for risk and opportunity, and the ability to deal with it well in the context of portfolio modelling seems likely to drive the best businesses in the next few years.
“There is no disputing that the landscape ahead for investing will be more interconnected and this points to developing diversification with an expanded toolkit,” says Mr Grohowski. “Markets will overreact, creating mis-valuations and opportunities that investors will need to take advantage of,” he adds.
“A broad diversification is especially important in a volatile market environment as we have at the moment,” says Andreas Russenberger, managing director of Credit Suisse in the asset management division, based in Zurich, and co-head of the Global Multi Asset Class Solutions department, which manages over SFr130bn (€100bn) for clients.
“The starting point always has to be the client’s individual asset allocation needs, ensuring an optimal risk/return profile, but there is a natural tendency for clients to have a disproportionate home bias while diversifying a portfolio globally is necessary to help optimise risks.”
Wealth managers say regional bias persists because their clients tend to have greater confidence in local stocks because they think they have better access to relevant information, but this is doubtful. It is a behavioural finance matter. Many are now building portfolios using a series of global managers.
“I have worked with many clients at the distribution houses, private banks and multi-managers and we are seeing a change in the way they are building portfolios, generally building up regional allocations at the expense of the domestic market, usually by using an increasing number of global equity managers,” says Skagen’s Mr Heffer. “There is a much stronger interest in global equity across the wealth management universe, reflecting the changes we see in the institutional pension fund space, where generally they are taking allocations away from domestic managers.
“Global managers have access to a wide range of options and so have a greater opportunity to add value, to be more flexible and to seek value, and of course they are not (as strictly) benchmarked. The MSCI World is less concentrated and distorted than the UK index, without those huge weights to individual stocks or sectors such as banking. We are therefore less likely to see managers hugging the benchmark, and being completely unconstrained is proven to be the best way of gaining alpha for clients.”
