“Why sometimes I’ve believed as many as six impossible things before breakfast.” — Lewis Carroll
In the land of managing investment portfolios, it all hinges on identifying sensible investment ideas to add value, as frequently as possible, and with as much conviction as possible. The high conviction is necessary because typically managers have to (i) convince their governing body that the idea makes sense and (ii) implement the idea in a timely and efficient manner.
Over the last few years, a number of compelling investment opportunities have presented themselves:
- Short credit positions or equity trades on low volatility in 2006
- Long credit positions or equity overweights in early 2009
- Emerging market exposures since 2005
- Commodity exposures since 2009
- Quality dividend shares exposures since 2009
As we approach the latter half of 2011, a question arises as to what such strategy might best serve in the coming period.
Market commentators are evenly split between bulls and bears, Europe and the U.S. are facing uncertain credit ratings and emerging markets appear to have temporarily run out of steam. Forward curves have already priced in rising rates, real return bonds have rallied in anticipation of future inflation (fueled by pension fund demands), fears of deflation and a “double dip” still linger and gold has risen even faster than oil prices (thus proving that glitter and security is preferred over gasoline and the freedom of the open road).
Some ideas for future portfolio positioning include:
- focus on traditional deep value security selection and credit analysis;
- have preference for dividends and income over uncertain capital appreciation;
- place emphasis on investments that reflect long-term infrastructure growth in emerging economies;
- avoid complex illiquid structures that have delivered little value to asset owners; and
- review structures to ensure that one focuses on securing “alpha” and not “beta” from any active management bets.
Unfortunately, with all the emphasis on risk management and “liability driven investing,” we may be forgetting the need to take investment risk to secure return and the need to spend more time worrying about investment outcomes (“making money for the fund”) and less time worrying about process and reports. A recent survey of retail investors showed that they associated higher risk investment strategies with lower expected investment returns. We need to take risk to secure returns.
Our job as fund managers is to take modest investment risks, after thoughtful analysis and consideration, in the expectation that we will be rewarded if we succeed, reprimanded gently if we fail and punished severely if the risk exposure was outsized or blatantly stupid. While we may be facing more uncertainty in the markets than we have in a while, we may also be facing far more distractions to our fiduciary job of managing the money. Like Lewis Carroll, perhaps we need to target at least six “impossible” investment ideas before breakfast every day, have the courage to persuade our governing bodies to allow us to implement them and stop being distracted by the idea that managing pension funds needs to be complicated.