Both interest rates and capital-market return assumptions are low and, yet, return requirements for investors remain high. This means investors may have to take on more risk than they are comfortable with to meet their return objectives. Hence, reliable sources of extra return and real-time risk management are crucial. In a low-return environment, the only way to realistically meet return targets is by moving up the risk spectrum or by making assets work harder and smarter. Making assets work harder and smarter takes time, effort and real-time, dynamic portfolio management. One emerging best practice in the multi-asset portfolio space involves building portfolios that are geared to an investor’s objectives rather than choosing a series of asset-class funds individually designed to provide benchmark relative returns.
This approach involves three main characteristics. The first is holistic risk management, or the understanding that portfolios need to be managed from the total perspective, taking into account cross-strategy risk and the devastating impact of low-probability tail-risk events and how they impact the likelihood of meeting portfolio goals. This involves cross-asset-class risk management and hedging techniques.
Second, portfolios must be nimble. With high volatility in the marketplace driven by unsettled economic and political times and the unprecedented speed with which new information impacts market prices, opportunities are fleeting and risks are everywhere. Nimble portfolios use shorter idea-to-implementation time lags and allow for proactive real-time risk management rather than reactive (after the quarter end).
Third, multi-asset portfolios should involve total portfolio management, in other words, integrated, purposeful and continuous management of the total portfolio, with targeting of total objectives, management of aggregate risk exposures and skilful use of a rich toolkit of capabilities.
To manage portfolios effectively on an ongoing basis, portfolio managers are required to do three things, which, on the surface seem simple but, in reality, require a unique set of skills, tools and capabilities:
1) Know where you want to be. Portfolio managers need to have a view on portfolio exposures and risk positions. Every source of risk in the portfolio needs to come with an expectation of being rewarded, or it should be removed.
2) Know what you own. First, however, a portfolio manager must know all the positions and sources of risk. While this seems like a simple task, in multi-strategy portfolios the amount of data and systems required to accurately look through portfolios is quite daunting for most investors. This includes not only knowing how assets are allocated, but through an aggregation of daily holdings, knowing the exposures and risks on a daily basis.
3) Be able to align the portfolio with where you want to be. Preferred positioning and understanding of exposures and risks does no good if you do not have the willingness or capacity to act. Only views implemented in the portfolio lead to better outcomes. Proper tools to move the portfolio in line with the portfolio manager view are essential for success.
By Brian Meath is managing director, portfolio manager, Russell Investments, U.S.