The combination of a challenging, volatile capital markets environment and a voracious appetite among a range of institutional investors for private capital necessitates a need for education and engagement like never before. But too often in recent years the asset management industry has responded to these shifting dynamics with product rather than what we would term the "professionalism" which this moment demands.
Four decades of nearly uninterrupted Goldilocks conditions for investment returns have reached their long-dreaded end. The downward march of interest rates, absence of inflation and an orchestrated central bank injection of endless liquidity that defined most of the last 40 years sharply and violently reversed in 2022. Meeting client outcomes has suddenly become much more challenging and will require deeper creativity and sophistication. In particular, what we at the Chartered Alternative Investment Analyst, or CAIA Association, have deemed the "portfolio for the future" will demand greater levels of diversification across risk premia, particularly in less liquid, complex asset classes.
These tectonic shifts have ushered in a new epoch, one that raises the bar for all practitioners and requires a refreshed collective pledge to a fiduciary mindset. We call this a "renewed professionalism": a demonstrated level of competency and an unwavering commitment to a set of ethical standards.
There are six guiding principles we are calling on all in our industry to embrace in order to properly navigate this new array of headwinds with the investor at the core of all we do:
- Cultivate a transparent and client-centered ethos. Professionals must ensure a fiduciary mindset is the central wiring system of their decision making, investment strategy and firm structure. The primacy of client interests must permeate and influence compensation philosophy, recruiting methodology, fee structure and alignment, communication style, benchmark choices and asset allocation.
- Start with purpose-driven building blocks. The entire apparatus of our industry is built on the taxonomy of asset classes. While certainly well-intended, the academy, professional designations (CAIA included), consultant practices and even our organizational charts anchor the entire ecosystem to this arbitrary categorization of portfolios. Mean variance optimization, strategic asset allocation processes, "60/40" debates and learning and development paths of our talent perpetuate the problem. Asset classes should be a residual, not a starting point. Dogmatic bucketing of strategies into traditional asset classes often assigns return and risk drivers inappropriately, creates silo investment thinking and engenders duplication across categories. Professionals should begin by curating exposures and risk factors that meet the unique purposes of that particular client, ensuring growth, income, inflation protection and capital preservation are all proportionally applied at a bespoke level. Holistic portfolio management constructs like goals-based investing and total portfolio management are important advances in this vein.
- Diagnose your client's values and embed tailored sustainability factors in your process. Sustainability should not be a box-checking, one-size-fits-all overlay in the form of a three-letter acronym. There is no such thing as an ESG fund or strategy. Approaching sustainability as one score or rating ignores client priority, impact and even conflicts of the multitude of underlying factors. Instead, identify the most pressing outcomes dear to the client and use a financial statement lens to embed these material influences deep into the investment process. These may come, for example, in the form of balance sheet write-downs (stranded assets), return on investment accelerators (leadership diversity) or litigation risk reserves (employee safety).
- Treat liquidity as a feature, not a benefit. Most clients' portfolios, with the exception of underfunded pension funds and wealth management accounts in the decumulation phase, have much more liquidity than they need. And yet, we continue to condition clients and ourselves to consider frequent and full liquidity as table stakes to assessing investment strategies or managers. Professionals must realize and educate their clients that realization of operational improvements in private companies and appreciation in long-dated assets is only possible through disciplined, locked up capital. Liquidity is neither inherently good nor bad; it is one of several important factors in considering whether an investment is in the best interest of a specific client. More intellectually honest matching of client assets and liabilities as well as clear and open communication about the unique risks of idiosyncratic, illiquid strategies is critical.
- Identify and capitalize on your firm's edge. We celebrate self-awareness with individuals and leaders and yet it is absent in our organizational identity. Professionals should devote time to diagnosing both inherent advantages (time horizon, talent, networks) as well as cultivated advantages (culture, technology, governance, innovation) of their own firms and their investment partners. Once identified, these advantages should be exploited through levers such as resource allocation, constant reinforcement, hiring practices and compensation. Clients should fully understand the specific role that each investment is fulfilling, why they are uniquely positioned to do so and how you and they are monitoring consistent allegiance to that edge.
- Invest with integrity and allocate to true partners. When selecting managers, advisers and asset owners are effectively delegating a portion of their fiduciary duty. But delegating does not mean abdicating. We must not take this duty lightly. Chasing the new shiny object or compromising on integrity for promises of outsized returns rarely works out and more importantly, violates that sacred oath to your beneficiary. What types of questions are you asking in your due diligence? Which are the most important? Make sure to deeply understand how they behave in stressful or poor market conditions, how they share upside (and downside) across the firm, whether they truly subscribe to a set of cultural values and their methodology of performance presentation. Bring the partner back to partnerships.
Our clients' collective dignity and retirement dreams are ours to steward. This fact should never be taken lightly. But the capital markets seas look choppier than they have in years. As private capital attempts to guard against the storm, investment professionals must ensure a client-first mentality flows through all they do or risk a credibility reckoning from which our space may be hard pressed to recover.
Delivering a purpose-driven investment return for a client over the course of multiple cycles is wholly dependent on your commitment to being a true professional. The industry needs to be reoriented back toward a north star of sophisticated portfolio construction, one that prioritizes client and beneficiary outcomes and works tirelessly to achieve those outcomes in a long-term, sustainable way.
John Bowman is executive vice president of the Chartered Alternative Investment Analyst Association, or CAIA, based in Salt Lake City. 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.