Global Head of Client Solutions
P&I: You've been meeting with CIOs around the world. What topics have been dominating these conversations?
Neil Blundell: CIOs continue to face an increasingly challenging landscape. The investment world has become much more complicated and dynamic than even five years ago, and the pace of that change is only intensifying. Return estimates are lower, real diversification is elusive, and fee and resource pressures result in intensifying portfolio and manager scrutiny. However, these challenges are driving new areas of innovation, both in investment strategies and in the relationships between institutional investors and asset managers.
P&I: What are the key areas that CIOs are focusing on today?
Neil Blundell: I would say there are five general areas that continually surface in conversations. In terms of specific investment topics, there continues to be great interest around navigating market regimes, factor utilization, private markets and a focus on outcome-oriented investing. The topic I hear most often, however, is simply the need to get more from their investment managers — more insights, more value, more support — for lower fees.
Today's CIOs are expected to be expert-generalists across a diverse range of extremely complex areas — new investment approaches, quantitative expertise, emerging technologies, regulatory challenges, etc. One way to help address the “master of all” challenge, particularly in light of pervasive staffing constraints, is to focus on building higher-quality, value-driven, strategic partnerships with fewer investment managers. Not only does this relationship consolidation tend to help reduce expenses, but the knowledge transfer that typically occurs as these types of bonds deepen can be equally important.
Within strategic partnerships, a strong understanding of a CIO's investment goals creates opportunities for managers to share their market insights and investment views, provide research and analytics support, and evaluate portfolio exposures in the context of changing risk climates. These relationships feature high-touch knowledge-sharing that is tailored to a client's specific needs, which may include anything from refining asset allocation to collaborating on investment opportunities in private markets.
There are softer benefits as well, such as potential cross-training opportunities or areas where you can capture greater operational efficiencies. The key takeaway? CIOs are determining how they can fully leverage the resources and best thinking of their top managers.
P&I: So that's getting greater value from fewer but more strategic relationships. How are investors addressing “regime investing” in their portfolio decisions?
Neil Blundell: Savvy investors always want to know where markets are in the cycle and how this might affect marginal shifts in portfolio positioning for both long-term strategic and opportunistic allocations. However, the current environment has made regime investing challenging for many CIOs. We have had a very long bull market in U.S. equities, which may have lulled investors into a false sense of security, with diversification potentially taking a back seat. Investors know intellectually this cannot last forever, but they also remain fearful of missing out on additional gains because the market seems to keep rising. This has created a high degree of uncertainty without a clear path ahead, and trying to predict a regime change in this type of climate can be problematic — no one wants to be wrong and alone.
This is another area where investors can gain insights from their strategic partners by utilizing their managers' capital market assumptions to help confirm or inform their own outlooks. At Invesco (IVZ), we develop a long-term outlook on a 10-year forward-looking basis to help set strategic allocations. This time horizon will generally see investors through an entire cycle. We supplement these with shorter-term five-year estimates to help showcase relative value opportunities within a particular regime. All of these sets of data can offer interesting insights, both on their own as well as when used in conjunction with each other.
Investors can use this type of information along with their own core tenets to test assumptions. What are a portfolio's exposures today and how do these behave in certain regimes? Understanding portfolio behavior — downside exposures in particular — under various scenarios can be critical in determining optimal allocations and implementation.
P&I: You also mentioned factor usage. What insights are you seeing here?
Neil Blundell: The criticality of looking at a portfolio through a factor lens is another topic that comes up in nearly every discussion. Higher correlations across traditional assets point to the increasing difficulty of finding strategies that can help diversify risks while maintaining higher-return objectives. As the understanding of the role that factors can play in investment returns has grown, it has provided investors with another effective risk management tool by offering a deeper understanding of portfolio and manager performance.
P&I: From your experience, how do you see CIOs utilizing factors?
Neil Blundell: My conversations typically center around three areas of factor implementation.
One: Utilizing factors to diversify in an efficient and cost-effective way. CIOs are evaluating ways to tap into positively rewarded style premiums in order to outperform traditional market-cap weight indexes. While factor strategies first emerged in equities, new multi-factor strategies are increasingly available across fixed income, currencies and commodities, as well as long/short premia. These innovations continue to expand the factor toolkit across both traditional and alternative strategies.
Two: Looking to factors to help with manager selection through insight into the scale and consistency of excess returns. Factor-return analysis can reveal if an active manager is adding value or merely employing static factor bets, which can be captured more efficiently through passive or factor strategies. These insights can be extremely useful in manager selection, and their role in driving allocation decisions is reshaping the industry.
And finally, to fundamentally better understand portfolio risks by using factors to manage overall portfolio tilts and implications at a strategic level. Analyzing a portfolio's aggregate factor exposures may uncover possible over- or under-weightings to particular macro or style characteristics. Specific factor exposures can be incorporated into the asset allocation to help optimize the overall portfolio's risk/reward attributes. It is important for CIOs to have a clear lens into intended and unintended bets.
P&I: What trends do you see CIOs grappling with regarding allocations to private markets?
Neil Blundell: Given today's lower return environment and convergence of broader market correlations, it's no surprise that alternative allocations continue to increase. In response, the alternatives market has also broadened and grown more complex. This has created a real need for expertise and support around private markets. Are investors allocating capital to illiquid investments efficiently? Are they maximizing the potential of alternatives to reach their desired outcomes? Are they properly accounting for how illiquid investments affect their overall portfolio positioning? As the spectrum of alternatives has become more diverse, it has become even more important to thoroughly understand these exposures.
While these investments can be very attractive on an uncorrelated, risk-adjusted return basis, they also add a layer of complexity, and it is critical to ensure that the risks and liquidity considerations, as well as the typically higher investment fees, are justified by what the strategy potentially brings to a portfolio. For example, it's important to assess how much traditional market exposure might be embedded in an alternative strategy. Is the allocation truly uncorrelated to the rest of the portfolio? How do you define and quantify risk in a segment like private equity? We model our clients' portfolios so we can collectively understand the cross correlations of exposures between public and private markets in an effort to continuously enhance asset allocation decisions.
P&I: How has the thinking of asset owners evolved relative to outcome investing?
Neil Blundell: We're having more conversations around developing investment strategies that are tied to specific goals. Discussions include questions like, how can I better align my investment strategy to meet my liabilities and how can I better manage to specific cash flows? These types of questions point to approaches like liability driven investing (LDI), cash-flow driven investing (CDI) and goals-based investing, which all have similar objectives: managing to specific outcomes. In this context, portfolios are managed relative to liabilities rather than to specified market benchmarks.
CIOs today are confronting a difficult tightrope when it comes to balancing the need for growing assets, in what is likely to be a lower-return environment moving ahead, and preserving capital, to manage against generally higher-volatility expectations. In this kind of environment, investors should consider a degree of LDI- or CDI-based strategies.
Furthermore, these are generally multi-period problems where complexity increases as more realistic inputs are incorporated. They can require substantial expertise in implementation. What is your funding ratio volatility? What are key sources of risk? Is there enough liquidity to fund short-term cash flows? Optimizing investment exposures under this more holistic view requires the understanding that it isn't about getting more growth or greater portfolio balance, per se, but about getting the right growth or right balance in the context of a particular set of liabilities.
The good news is that CIOs don't have to face the challenges in these five areas alone. Many leading investment managers offer advisory consultation, custom solutions and strategic partnerships that can offer transformative thinking about how best to position a portfolio for optimized outcome potential. These highly experienced solution teams can provide sophisticated diagnostics, portfolio-modeling best practices and new advancements in investment innovation. By accessing these types of services, CIOs can tap into a valuable investment resource to help solve a broad range of portfolio challenges — not just in the current investment environment, but also for many years to come.
Source: Invesco (IVZ) analysis. Data as of September 20, 2018, unless otherwise stated. All content provided by Invesco is for informational purposes only and is not an offer to buy or sell any financial instruments. Invesco Advisers Inc. is an investment adviser; it provides investment advisory services to individual and institutional clients and does not sell securities.