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This discussion is sponsored by Absa, a member of Barclays and David Williams is with Deslin Naidoo. Deslin the Absa Investment Conference theme has been ‘Improving Investor Outcomes’. What have you had to say on this topic?
I think one of the big things that is being discussed right now is does active management add any more value to the outcome of an investor? I think that’s largely in debate because of the underperformance that’s been seen in the active management space but particularly in equities.
We tend to forget that there are a number of other asset classes that are involved, which include fixed income. That includes the alternative asset space, and within all of that definition of ‘is active is dead’ starts to become slightly opaque.
Before we talk about how active management is doing. That, in my opinion, is the last part of the value chain, in terms of an outcome for investing. It’s the implementation element, so if you start with the value chain, whether it’s th e retail side or the institutional side, it comes down to defining an objective.
What is it that you want your money to do for you? If you are trying to maximise wealth because you’re trying to leave a legacy for your kids, that’s very different from a Pension Fund’s objective, which is to create income for you on retirement, which is very different from saying I need to build an emergency fund over the next three years.
It demands a different understanding of the risk appetite. The time horizon and the use of that particular capital that is the starting point of any investment strategy, and it emphasises the importance of having an advisor or a consultant because they have line of sight of what I call the liability, which is that definition.
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Once you understand that liability you need to understand how you’re going to go about developing an asset strategy to meet that liability? Now that, in my opinion, is where your first active management start. It doesn’t start with your asset manager. It’s that active management decision if your investment starts way before that.
You’re broadening the definition of ‘active’?
Correct. There’ve been papers that have said 90% of your return is explained by your asset allocation, so you get that wrong, you miss the ability to meet your liability and, as a result, you meet your objective because that liability is the translation of your objective.
Another thing that people tend to forget: in the retail space, they use risk profile questionnaires but they don’t really look at it in the institutional space, there’s the utility ‘how much risk can you tolerate’?
Now, having risk profile questionnaires that talk about high risk, medium risk, or moderate risk, in fact 90 percent of them will put an investor in market risk because it’s just the way these questionnaires are structured. If you start being more tangible and converting these qualitative elements into more quantitative elements – I call that a risk budget, you can apply, essentially the brakes to your investment strategy.
Everyone will have different brakes and depending on the type of objective you have and depending on the type of individual you have.
Think of it as you’re driving a car, you could drive it on the racetrack, the normal road, off-road, the desert – each one requires a different kind of setup. Each one requires a different kind of balance of attributes. The amount of fuel you have, the weight, tyre size, engine size and all of these things. That’s what your investment strategy in the active management of your investment strategy really starts at.
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Once you have that you translate it to what’s the asset strategy? Is there a need to take on risk? Can a passive strategy deliver on your objective straight off or do you need more return in order to meet that particular outcome that you’ve set? If you do need more return, that’s when you have to say, “How do I apply my risk budget to it?”
There’s a second element of that. Maybe you have the tolerance for risk, and I can say to you because you have a higher risk tolerance. Instead of contributing R1 000.00 per month to your objective, you can contribute R800.00 per month.
That becomes a capital allocation question, which is something that’s completely dismissed in anyone’s investment strategy type of discussion that’s happening now. They obviously want to get as much money out of you, for the savings function but you have an infinite set of saving objectives, so it’s investing in some form of scarcity type of setup.
That, in my opinion, is where the crux of asset management and active management is going and not what the asset manager is doing at the end of the day, trying to beat some market cap index or high performance.
We’ll have to stop there I’m afraid, thanks Deslin Naidoo.
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