Investment consultants say the sensitivity of investment portfolios to macro factors such as liquidity, inflation or currency movements will play an increasingly important role in how they evaluate money managers in coming years.
Spurred by the recent market meltdown, that trend reflects the growing sense that “we need another level of sophistication as we build portfolios, particularly on the risk side,” said Terry A. Dennison, a Los Angeles-based worldwide partner and U.S. director of consulting with Mercer Investment Consulting Inc.
How portfolios are affected by factors such as inflation, availability of credit or the level of government intervention is increasingly “something we'll be thinking about when we talk with managers,” he said.
The experiences of 2008 and 2009 clearly showed that “the standard buckets of how to think about managers didn't necessarily give you a full picture” of the risks facing institutional portfolios, said Erik Knutzen, chief investment officer with Cambridge, Mass.-based investment consultant NEPC LLC.
Eric J. Petroff, director of research with investment consultant Wurts & Associates Inc., Seattle, said the challenge now is moving beyond the backward-looking data on which consultants have traditionally relied. Instead, he said, they need to examine how a manager's unique investment philosophy and style react with various macro factors, such as GDP growth, credit spreads and inflation.
Using that information in combination with macro forecasts would leave the investment consultant better positioned to help clients construct their portfolios, Mr. Petroff said. It would give clients an analytical framework to tactically underweight or overweight their managers, if they chose to do so. Conversely, the types of insights such analysis would provide could help convince clients to remain patient with managers suffering through a stretch of underperformance, avoiding the pitfall of firing a manager at exactly the wrong time, he said.
Some consultants say the journey, while worth taking, won't be easy.
“Conceptually, it makes sense, but the challenge will be in the implementation,” said Michael Rosen, a principal and chief investment officer with Santa Monica, Calif.-based Angeles Investment Advisors.
Understanding what the exposures of specific portfolios are to macro factors is hard enough, but then coming to grips with whether those exposures are static or sensitive to change adds another level of complexity, Mr. Rosen said. He considers such factors in “broader, less precise, less quantitative ways.”
Proponents concede they're still working out the details.
On a conceptual level, NEPC is thinking more about common risk factors when it comes to manager selection, while continuing to strengthen the analytical framework needed to put that conceptual understanding to work, said Mr. Knutzen.
It's “a different way of viewing things” with a lot of pieces that need to be thought out, affecting everything from risk management to portfolio construction, said Mercer's Mr. Dennison.
But having lived through the same trial by fire of the past few years, everybody is moving in the same direction — looking to take a less statistical viewpoint and a more behavioralist one of how specific managers are likely to perform in certain macro environments in an effort to further limit the risks to which the broader portfolio is exposed, he said.
That can be as simple as being sure to combine managers with a relative view of valuation, who would consider buying the least overvalued stock in a high-flying sector, with those who would look in other sectors if absolute valuations appeared stretched across the board, Mr. Dennison said.