Last year was difficult for multiasset managers all over the world. This year will also be challenging, due to a slowdown in global growth and increased volatility resulting from political factors. An asset manager that can help asset owners navigate this environment is imperative. However, the key to continued success is less about the investment process and more about the way in which a team is structured, along with its culture and accountability.
True multiasset investing is a relatively young investment approach, so few teams will have been through the turmoil of 2007 and 2008 and may be unprepared for challenges ahead. There are several keys to maintaining a successful team through more difficult times.
People are key
Research shows a link between good culture and good results. The fundamental reality is that investment is about people. The "market" is an agglomeration of millions of people (professional investors, institutions, individuals) all seeking to generate wealth. Investment teams are microcosms of the broader market environment, thus the question of creating a high-performing investment culture is inextricably linked with the individuals involved and their interactions. Indeed, the importance of human behavior to market performance is the reason why investment philosophies are necessary. If investing were an exact science, there would be no need for a philosophy; we could just calculate the exact intrinsic value of any cash flow and that would determine the correct price of the asset.
Coping with mistakes
When it comes to investment philosophies, many emphasize (increasingly scarce) informational advantages, but research into institutional investors shows culture is the true competitive advantage, as it is more difficult to replicate. The most important part of culture is dealing with behavioral issues and coping with mistakes. The reality of being a portfolio manager is, even if you are successful, you are probably making wrong decisions 40% of the time. How can you create investment processes that manage that chronic failure and maintain investment performance? How can you identify and minimize mistakes that stem from cognitive bias and ensure that you "fail better" than others?
There are five key elements to structuring a successful multiasset team:
1. Accountability. It is human nature to want to focus on one's successes and explain away one's failures. This natural human tendency is corrosive to investment performance and compounded even greater depending on the number of people involved in a decision, as groupthink may occur. Sometimes it is easier to go with the crowd, as the peer comparison risk is lower. The impact of one's decisions needs to be measured and an individual needs to be held accountable for decisions linked to financial incentives. This ensures earlier recognition of mistakes.
2. Skin in the game. Traditionally, multiasset investment committees consisted of various representatives of the asset classes comprising the portfolio. To help make asset allocation decisions, these representatives were asked to provide the case for their particular asset class. Therefore, espousing the relative merits of different asset classes were not necessarily their day job or what they were rewarded for. As a result, they had no 'skin in the game' for making such calls in the sense that they would not be measured and rewarded for these kinds of decisions. They are rewarded for generating good performance within their respective asset classes and as a result, attracting more assets. Thus, there might be an upward bias in terms of their forecasts of assessment of prospects for their asset class.
3. Size of the decision-making team. If a committee is too large, it becomes unwieldy, lacks coordination and accommodates passengers. In fact, the phenomenon known as the Ringelmann effect describes the tendency for individual members of a group to become increasingly less effective as the size of the group increases. Too small a team becomes undemocratic and overconcentrated. Some social scientists have suggested that five or six may be the optimal size of a team. There is a definite 'Goldilocks' effect when considering the appropriate size of an investment team.
4. Creating healthy rivalry. Increasing bench strength of an overall team is important, and competition for places is vital to keep team members on their toes and avoid complacency. It is important to give emerging talent a chance to show what they can do and participate and be measured in the same way as full members of the investment committee. Incumbent members should be aware that they can be replaced. A flat structure with little hierarchy encourages open debate and challenging of investment positions.
5. Diversity of thought. This concept is imperative to ensure investments and risk are analyzed from every angle. Although the concept of diversity of thought is now quite fashionable, some researchers suggest that too much diversity is undesirable as similar individuals are more likely to share values and thus work more effectively toward a common goal. Bringing individuals together with opposing perspectives should be looked at as a "controlled explosion," in which team members confront each other about ideas but aggressive or patronizing behaviors are not tolerated. Team leaders must ensure individuals feel heard throughout the process. In short, badly managed diversity can have very negative outcomes, while well-managed diversity allows us to continue to grow and develop.
Lastly, the "grease" that allows all these elements to work together is trust. Trust increases the resilience of the team to the pressures of accountability, rivalry and diversity. There are no shortcuts, trust is built over years of working together under common standards of behavior.
After more than 21 years as a multiasset investor, I believe that it is increasingly important to actively identify and minimize mistakes that stem from cognitive bias. At all times learning how to fail well and deal with mistakes is imperative to ongoing success, but in tough times, this ability is the key to competitive advantage.
An investment process that focuses on analytical advantages is clearly important, but the culture, structure, trust and the accountability of the team are what sets teams apart from the competition.
Johanna Kyrklund is the global head of multiasset investments at Schroders PLC, London. This content represents the views of the author. It was submitted and edited under Pensions & Investments guidelines, but is not a product of P&I's editorial team.