By Stuart MacDonald
The last decade has seen some of the most volatile episodes ever in financial markets, making them extremely difficult for even expert fund managers to navigate. The consequent shortcomings in performance mean many investors question traditional approaches to investment.
Research commissioned by Aquila Capital revealed that three out of five (59%) of European institutional investors say the funds in which they invested over the last 10 years only partially met their expectations, or failed to do so entirely. One in six (17%) say at least half of the funds in which they invested over the decade exceeded their risk tolerance.
What was also interesting in the research was the extent to which investors accept the futility of trying to base investment on prediction. Only 10% believe it is possible to invest successfully on a sustainable basis by predicting future moves at the level of individual securities or even sectors, countries or asset classes.
It may be that faith in the abilities of fund managers to predict market movements reliably has diminished because market conditions have become more difficult or there are too many players chasing excess returns in areas in which it is difficult to obtain an edge. The well-documented rise in inflows to beta products in recent years reflects a change in investor appetites.
Equally, the growth of algorithmic trading, as well as the current environment of risk-on/risk-off as central banks have become the prime drivers of the markets, have made it more difficult to second-guess the markets.
The difficulties in making coherent market calls are admitted by many managers themselves. It has, for example, notably affected the trend-followers in the CTA space and many macro players.
Diversification has always been crucial as way to deal with this issue, but the point is to have exposure to assets that are actually uncorrelated. Weaknesses in the traditional cap-weighted portfolios consisting of 60% equities/40% bonds came to the fore during the crisis when all of the main asset classes went south. It has now become more important to investors to make strategic allocations with a greater and more sophisticated appreciation of risk.
There still seems, however, to be a hard core of investors who think that predictions at the level of stock-picking are entirely feasible. Do they have unrealistic expectations about what can be delivered?
Skill-based managers being able to stay one step ahead of the market do exist at, for example, the credible end of smart beta plays, small caps, special situation or event-driven plays. This usually involves receiving or interpreting information that is not necessarily all in the numbers. But these players do seem to be confined increasingly to particular niches.
Looking ahead, what does this mean for investors as well as investment managers? First, an increasing and healthier emphasis being placed on capturing long-term risk premia rather than the pursuit of short term gains that are generated by educated guesswork, as opposed to strategic observation. In short, there should be a greater emphasis on intelligent approaches to risk. Second, as with many other industries, the investor (in other words, the consumer) may finally be able to demand that investment managers (with or without the explicit support of regulators) actually deliver what is said on the proverbial tin.
Stuart MacDonald is managing director at Aquila Capital
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