As investors open their year-end statements and along with them their Client Realtionship Model – phase 2 (CRMII) performance summaries there are a few things that should be kept in mind, especially when it comes to analyzing the value their portfolio managers are providing.
As an Outsourced Chief Investment Officer (OCIO), we get to see a multitude of investment strategies so we have a decent understanding of what has been working particularly well and what hasn’t both recently and over the past few years.
In particular, high-net-worth investors and their family offices and multi-family offices tend to deploy a multi-manager approach to investing. This means utilizing both passive and active public globally diversified portfolios along with risk-managed, low-volatility alternative strategies. For those with larger accounts there can also be a component of private equity, co-investing, venture cap, private debt and real estate.
As part of our quarterly review of each of these portfolio managers, we often notice that some strategies are performing quite well while others may be challenged by market conditions based on their geographical area of focus or their particular style of management.
In these cases we often have to remind ourselves that this is OK: You don’t want the different managers and strategies to move together, because if they do you risk losing the benefits of diversification when markets correct — something that had not happened for some time before the last few trading days.
However, showing restraint is a lot more difficult than it sounds. It is awfully tempting to own more of those strategies, sectors or geographical locations that are doing well and less of those underperforming.
Take the U.S. equity market, for example. It has been a top performer, while Canadian and EAFE (Europe, Australasia and Far East) markets have had ups and downs but are for the most part flat over the longer term. For example, the S&P TSX has now fallen 2 per cent below its latest high set in August 2014, meaning returns over the past three-and-a-half years have been slightly negative. And it’s not that much better over the past decade, as the TSX is only about 1.7 per cent above its all-time high set in June 2008.
Looking abroad, the MSCI EAFE index remains 1.6 per cent below its most recent June 2014 high but is much worse over the past decade, remaining 19 per cent below its October 2007 all-time high. Then there are the extremely volatile emerging markets that thanks to a strong 2017 have reduced their loss to 5.6 per cent below its most recent April 2011 highs but are still 15 per cent below their October 2007 all-time highs.
The past few years have also been a very challenging environment for risk-managers given the large inflow into equity ETFs, which have bid up stock valuations for both good and bad companies alike. Record low levels of volatility has also meant poorer returns for those who used this environment to hedge compared to those who simply owned the market. For example, the Barclay Equity Market Neutral Index posted gains of only 2.9 per cent last year, 0.6 per cent in 2016 and 5.2 per cent in 2015.
Not surprisingly, investors have reacted to all of this by diverting funds away from these markets and strategies while drawing down cash levels to decade lows by stepping in to buy even more of the U.S. equity market, making it a very crowded trade at the moment.
At times like these, it’s especially important to determine how effectively portfolio managers are deploying their strategies and how they compare to peers with a similar style of management.
One should ensure that those managers operating in an out-of-favour market or sector are not abandoning their investment process — for example, a value-based equity manager shifting their portfolio toward momentum-focused holdings.
Another common mistake occurs when a client’s managers don’t match what the client says they are trying to achieve as outlined in their investment policy statement — for example, when those that find it important to track the market do not have enough holdings with a passive equity focus.
Finally, allow that inner-contrarian to thrive and look to rebalance on large moves in either direction among the various segments in your portfolio.
Martin Pelletier, CFA is a Portfolio Manager and OCIO at TriVest Wealth Counsel Ltd, a Calgary-based private client and institutional investment firm specializing in discretionary risk-managed portfolios as well as investment audit and oversight services.