This then begs a rather important question: What will this new approach to asset allocation, and indeed institutional investment, imply for the organization and operation (i.e., behavior) of these funds? I guess what I’m wondering is whether we should expect institutional investors to begin hiring analysts and investment professionals into new groups focused on risks, such as a ‘credit group’, a ‘growth group’, an ‘inflation group’, etc? Or will they start giving mandates to “liquidity managers” or “interest rate managers”? Just as an investment bank has product groups (e.g., M&A, leveraged finance, and restructuring) and industry groups (FIG, TMT, Healthcare, Consumer, Energy, Real Estate, etc.), will institutional investors end up having asset groups and risk groups? Or will these investors end up dumping their asset groups altogether? It’s conceivable that this new way of thinking about allocation and diversification could translate into a complete overhaul of the design of institutional investors!
But…not yet. Why? Well, it’s called “path dependence”. At this point, re-organizing everybody would be much more costly than just tweaking things internally so as to hold onto the notion of risk, while still operating within traditional asset classes. The legacy institutions make innovation within many funds practically impossible. (Consider the challenge for a public fund that has a workforce with 80-90% unionized employees.) In these cases, the only way to innovate is to do so externally or, gasp, to get even bigger.
And that’s what one fund I’ve been talking to has done. This large fund decided to set up a new committee made up of all senior investment staff (i.e., group heads and the CIO) to, in effect, translate the old asset allocation framework (guiding operations within the investment groups) into the new risk framework (for the purpose of asset allocation at the Board level). So, for this fund at least, implementing a ‘risk-based allocation’ has required a new “translation committee” to relay the demands of the board (in terms of risk) to the investment staff (in terms of assets).
It’s definitely not what we’d design on a blank piece of paper, but, given the existing commitments and institutions, it’ll work. Click image below to enlarge.
This post originally appeared on the Oxford SWF Project