Ever wonder that it might be time to rethink your investment approach? Maybe not, but at the Canadian Pension & Benefits Institute’s Pension Summit last week in Toronto, investment managers presented a little food for thought on investing.
Robert Q. Wyckoff Jr., managing director of Tweedy, Brown Co. LLC based in Stamford, Conn., looked at value investing in volatile global equity markets.
Many institutional investors make the mistake of focusing on portfolio volatility, said Wyckoff. “Market volatility is corrosive.”
In a volatile market environment, many pension plans need to meet their funding requirements and have taken many steps to de-risk, he said, many after the fact.
They use liability-driven investment (LDI) strategies and more complex shorter strategies, he continued, but when volatility is most needed, these leverage strategies tend to provide little protection.
Though he admits that the use of LDI and the increased diversification in alternatives is understandable, Wyckoff said that these strategies can cause investors “costly mistakes.”
One alternative path to fix these mistakes is value investing, specifically exploiting the volatility to earn long-term risk-adjusted returns. But why don’t all investors follow this philosophy?
For one, “what defines value is highly correlated with unpopularity,” Wyckoff explained. “Many wear the label but don’t practise the discipline.”
And returns generated by a long-only value approach are often “lumpy and inconsistent.”
But the approach works. Wyckoff pointed to the Hospital for Sick Children in Toronto as an example. The hospital adopted a value investing strategy with no complexity and no leverage in 1995. As a result, its compound annual growth rate from March 1995 through to March 2013 was 11.2% for the pension fund.
“[The hospital] used and exploited the market instead of being enslaved by it,” said Wyckoff.
But if value investing is not for you, perhaps questioning value add in money managers is. Richard Rooney, president and chief investment officer of Burgundy Asset Management Ltd., looked at three reasons why managers don’t add value to investments.
First is size. Size can limit your opportunities, and it creates a smaller investable universe as managers get too big, Rooney said. So ask your money manager about their assets under management and how many stocks they hold.
Second is “closet indexing.” Managers need to focus on the active share, making sure they’re exploiting a quality opportunity that is different from the benchmark, Rooney explained. If you suspect that your manager is a closet indexer, ask what the active share is, how much value your manager has added after fees and if the result is meeting your expectations.
Third is lack of downside protection. Some managers investment processes no longer give you downside protection, said Rooney, stressing that a money manager must have a system in place to protect the downside. Ask your manager what is the largest percentage loss they has suffered in an investment and if they have ever been defrauded.
Interestingly, these three issues are all interconnected. Increase in size derives from the success of the money manager, closet indexing comes about as a result of the size, and the lack of downside protection comes from closet indexing, he said.