Borbidge’s team tests such questions in multiple ways. They look at forward expectations with CMAs, but they also perform historical and theoretical testing, via the Invesco Vision tool, to see how the portfolio might have performed in previous or hypothetical environments. Invesco then takes the findings and shows clients their likelihood of being able to deliver on desired outcomes — and what type of tweaks are needed to increase those odds.
Still, Borbidge said, while analytics is fundamental to the process, the power of the platform goes beyond just the numbers to how Invesco’s client solutions team delivers the message and insights for clients.
“Our client solutions team is very talented at distilling these insights down to a small number of actionable items that are easy for the investors to understand, implement and measure,” he said.
The investment process involves taking outcomes into consideration at every step — research, allocation, manager selection and portfolio construction — via a collaborative approach. The relationship begins with in-depth conversations and frontloaded research to understand the risk and return drivers of specific asset classes already in the portfolio.
Sometimes clients will have their own CMAs. In such cases, Invesco can serve as a sounding board, helping evaluate the validity of those assumptions through the Invesco Vision tool and providing feedback as to how they compare to Invesco’s CMAs.
“Alternatively, we can rely entirely on a client’s CMAs in proposing a solution or evaluating the sensitivity of a proposal on areas of difference,” Borbidge said.
Even clients without existing CMAs typically already have an investment strategy in place or preconceived notions of how they want to deliver on their desired outcome amidst current and expected market conditions.
“We need to start out by understanding what that client’s approach is to deliver on that investment strategy, and we also need to understand the goal of the investment strategy,” Borbidge said. “We do that by meeting with the client, asking a lot of questions, going back and forth — in terms of hearing their goal and articulating that into what we would say the investment language is around the goal — until we come to an agreement.”
New Level of Transparency
Next, the team examines those goals through both asset allocation and factor allocation lenses. The asset lens involves looking at CMAs for each asset class, including expected return, volatility and correlation with other asset classes, in terms of both current and historical market data.
Using the factor lens, analysts examine equity and fixed-income factors to make sure that the overall portfolio is tilting toward the desired outcome, keeping in mind that each factor may perform differently at various points in a market cycle. That focus on factors provides clients with a new level of transparency into their portfolios — and the risks they contain.
“We may see a concentration in a particular factor where an investor may have thought their portfolio was well diversified because they had broad coverage from an asset class standpoint, but the ways that they’ve gained access to those asset classes have similar factor characteristics across the board,” said Nicholas Savoulides, Invesco’s head of solutions research and portfolio analytics. “So a portfolio that on one level looks fairly well diversified actually has risk concentration that can have a meaningful impact — either positive or negative — on performance in certain market environments.”
Those insights provide investors an opportunity to understand their portfolios in ways they hadn’t previously. Invesco can then use those insights to determine whether it makes sense to remove holdings in assets or eliminate factors that aren’t contributing to the desired outcome, and then to determine other ways to construct the portfolio to better deliver on the goals developed throughout the process.
One outcome that has seen significant increase in demand is diversified growth across asset classes with downside protection. That demand reflects a continued need among pension funds to find ways to improve their funding ratio by growing their assets. But, of course, focusing too closely on growth can bring its own set of risks.
“The challenge is to be aware of how much risk you’re taking on,” Savoulides said. “You don’t want to make an underfunded plan more challenged by building a poorly diversified portfolio with added downside exposure.”
Another outcome that has been in high demand over the past decade is income generation. The approach to that outcome, however, has changed significantly in recent years following a continued decline in interest rates accompanied with tightening credit spreads. Both of these developments have bid up the price of income-generating assets. For defined contribution plans, the ability to deliver income — despite market challenges — is key, since offering income potential increases the likelihood that retirees will remain in the plan and stay on as clients.
Each specific outcome necessitates a unique approach to portfolio construction.
“There are certain asset classes that we would build and invest in for a total return portfolio that we would pass on when we’re investing for income,” Borbidge said. “For example, small-cap equities may have very attractive total returns, or even risk-adjusted return potential, but from an income-generation standpoint, small-cap equities in the United States tend not to deliver a lot in terms of dividends.”