The past, present and future of portfolio management

The discussion was divided into four short segments: the evolution of portfolio management techniques; megatrends; key markets for investment; and future models of wealth management

Portfolio management techniques

Key to transformation of portfolio management over the last 20 years has been the information explosion, with a huge increase in the volume, velocity and veracity of data, amid huge efforts from banks and fund houses to curate this. 

Yet, as Create-Research CEO Amin Rajan testified to our roundtable, this revolution has not solved the problems challenging asset management practitioners, trying in vain to get to grips with an industry increasingly governed by pronouncements of finance ministers and central bankers around the globe. 

“What markets require today are insights, not information,” he believes. “For example, if you look at today’s market, understanding the psychology of the market is extremely challenging at a time when central banks’ actions have severely distorted market valuations,” which currently reside in “Neverland”.

Data is not a great deal of help in understanding this market’s psychology, he said. “What is really important is investible insights. These amount to seeing things that everybody is seeing, but thinking what nobody has thought. That requires human judgement, rather than the kind of data revolution that we have experienced so far.”

Part of this judgement involves identifying which assets require more human intervention and imagination in their management, alongside those confined to a passive, mechanised programme. Currently, efficient markets such as US large caps are typically hived off to passive funds, while funds investing in smaller caps and developing economies are more likely to be actively managed, with the latter married to thematic investment ideas. 

“We gain exposure to those ideas via active managers,” said Caroline Simmons, UK chief investment officer at UBS Global Wealth Management. “And we are also increasingly using derivatives and actively managed certificates in the way that we’re accessing investment ideas.”

Portfolio management at the global level is all about effectively combining these passive and active strategies, believes Amundi’s group chief investment officer Pascal Blanqué . This mix is shaped by a new, inflationary economic environment, where old assumptions of natural diversification are called into question, believes Deutsche Bank’s Christian Nolting, highlighting the paramount importance of risk management when constructing portfolios.

This regime shift in portfolio management lends itself to increased allocations to private equity investments, although these should be handled with great care, according to Edmund Shing, global chief investment officer at BNP Paribas Wealth Management. 

“With private equity funds, trying to sort the wheat from the chaff is incredibly important,” he said. “There is an enormous difference in strategies, philosophies and long-term returns, from the best to the worst,” bringing manager selection into the spotlight. 

2 and 20 Forum video series

Watch the other videos in this series

Evolution of portfolio management - 2 and 20 Forum Ch 1/4

Megatrends in action - 2 and 20 Forum Ch 2/4

Focus on investment opportunities - 2 and 20 Forum Ch 3/4

Future wealth management models - 2 and 20 Forum Ch 4/4

Megatrends

Megatrends crucially allow investors to capitalise on selected growth points in the global economy and ride out market cycles, believes Mr Rajan of Create-Research. As a result of these benefits, their popularity has grown, reflected in the proliferation of ETFs. 

Not only do these trends, like the evolution of electric vehicles or Covid vaccines, for example, clearly disrupt existing business models over a prolonged period, they also “run with the grain of changes in the societal value system”, according to Mr Rajan. 

While these phenomena are clearly here to stay, there are two health warnings associated with megatrends, he said. Firstly, they need to be clearly defined. He gives the example of ESG investing, which many investors currently find confusing. Secondly, trends work well in hindsight, it being incredibly difficult to identify them at an early stage. 

Wealth managers also need to be wary of a modern-day scenario where thematic investments are doing well, but core portfolios are underperforming. “You have to make sure the two are playing very nicely together,” suggested Deutsche Bank’s Mr Nolting.

Here, larger banks can often be more successful through their purchasing power, enabling them to work with product providers. “Sometimes, if we’ve researched a particular theme or demographic-led trend where there is no product available, we can go to a product provider and ask them to help develop that with us,” said Ms Simmons at UBS.

Complying with an increasingly heavily regulated regime, with many layers of additional rules emerging after the global financial crisis of 2008, has gradually become an indelible part of this product creation process.

“It’s incumbent on us, in a position of CIO, to make sure that compliance are involved in the conversation as early as possible, so that you can go through the entire process very, very smoothly,” added David Storm, chief investment officer for British Isles and Asia at RBC Wealth Management. “We have to consider this at every stage. Effectively, it’s the hygiene part of the investment process.”

Key investment markets for wealth managers

Despite a psychological, regional bias amongst many clients, chief investment officers are today obligated to take a more global approach than 20 years ago, opening up a much broader palette of investments with greater diversification possibilities.

“We are already quite attuned to the idea of investing globally,” said Mr Storm at RBC. “As a CIO, it’s very important to open your clients’ eyes to the broad opportunity set.”

Currently, the only fixed income instruments which many clients may want to own are Chinese bonds, he said, which private banks can help them understand, bearing in mind they may be beyond their normal comfort zone.

With a juxtaposition of higher-risk emerging markets, including China, against developed markets linked to the dollar, private banks must help clients allocate between both strands when building a portfolio, believes Ms Simmons at UBS.

“Strategically, it’s very important to have both. Generally speaking, emerging markets are still higher growth and obviously, you want that in a longer-term portfolio. But they are also still higher risk,” said Ms Simmons.  

With the size of the Chinese market now in a broadly similar range to that of its UK equivalent, UBS says it is vital to allow clients access to China, in order to maximise returns. Although the bank currently weights portfolios more towards developed markets, asset allocations may be about to change. “Once we get into the second half of next year, then a lot more growth will be coming from the emerging markets,” she said.

Within this emerging markets segment, the balance between China and India – seen as major rivals in the late 1980s, when both had identical GDP levels – has changed significantly in recent times. “The growth super cycle that China has had, has really put it in poll position,” said Mr Rajan. “India has tried to catch up, but today, as we speak, the Chinese economy is six times bigger than the Indian economy.”

The “formidable strengths” associated with the Chinese leadership’s plans to transform China to superpower status in fields of artificial intelligence and green energy were contrasted with India’s greater level of democracy, subjecting it to much more checks and balances compared to its eastern neighbour when implementing “mega projects”.

But asset allocations to emerging economies still remain woefully small compared to their GDP, despite exciting growth dynamics, primarily because governance of family-owned and state-owned companies lags well behind standards approved by overseas investors, said Mr Rajan.

“This is where India can score, because India has tried to change its governance structures very significantly,” he added. “If India can sort out the governance structures, then India can give China a run for its money.”

Future wealth management models

The last two decades have seen an increased industrialisation and commoditisation of asset and wealth management, where size matters, as they take on more characteristics of a truly maturing industry. This is a trend which will accelerate in the future as the various moving parts  – such as beta and cap-weighted components of the products – are manufactured in an increasingly efficient process, said Pascal Blanqué  of Amundi.

He also expects the industry to be enlarged, fuelled by the incorporation of IT tools, modelling and management of liabilities, plus ESG preferences. “I think, to an extent, we are moving into a phase where people are looking at their portfolio with a sort of new efficient frontier or risk/return and ESG preference,” he said.

How we invest in ESG is still under intense discussion, however. “Pretty much everyone can agree that something needs to happen and something needs to happen fairly quickly,” said Mr Shing from BNP Paribas Wealth Management. “That’s been fairly well described in the media. But what exactly do we do? That’s where it gets trickier.”

Rather than the “binary approach” of including “good” companies in portfolios and excluding “bad’ ones, Mr Shing believes in a more innovative approach of encouraging bad companies to contribute towards the goal of a low carbon, more sustainable environment.

“Actually, what we need to do, maybe, is invest in the bad companies, but then put pressure on them to transform and I think that is happening,” said Mr Shing. “That is what I call more ESG 2.0. This is a journey we need to take our clients on.”

Engagement with these trends must be coupled with a “broadening of the investment shelf”, according to Ms Simmons at UBS, to include investment clubs and direct investments facilitating access to private equity and alternatives. Investment in start-ups, in addition to tried-and-tested listed stocks, is also a favourite of the next generation, yet comes with its own restrictions. 

“One area that established managers grapple with is trying to deal with the risks of making a responsible recommendation for something that has no track record,” she said. “That is a bit of a conundrum, I think yet to be resolved.”

These are dilemmas the industry has struggled to deal with, believes Mr Rajan. At the moment, wealth managers are failing to provide a “clear line of sight” linking green portfolios with a greener future for the planet. The nature of many “big behemoths” or super-scaled players that have resulted from mergers is that their increased bureaucracy stifles innovation and enterprise.

“I think that the future belongs to innovators, whether they be small or big,” concluded Mr Rajan. “Without innovation, I don’t really think that this current generation of the big merged companies are going to be around after another 10 years or so.”