“It’s about getting more bang for your risk buck,” says Morten Spenner, CEO of International Asset Management. “The choice word for 2014 is ‘selectivity’. People are sharpening their pencils across the board and are ultimately concentrating portfolios by increasing individual manager calls.”
Managed accounts
Investors are increasingly demanding active managers focus on their very best bets, a trend that is evidenced by the growing popularity of managed accounts. Getting fund managers to increase their risk can be challenging. Although relatively few positions within a portfolio will genuinely create alpha, the need to generate sustainable revenue puts pressure on managers to hold less valuable positions.
As Vickers explains: “Nobody has 50 good ideas. Most people are very cognisant of their benchmark and career risk. They may have 10 or so genuinely good ideas. The rest of the portfolio is not true to what investors are really looking for.” A survey by BNY Mellon in collaboration with Nobel Prize-winning economist Harry Markowitz, found investors ranked unmanaged/ unintended bets as their most important concern in addressing unintended risk. In 2008 what surprised many investors was not just the losses themselves, but the magnitude and source of those losses, creating a keener appreciation to understand all their risk exposures and eliminate the possibility of future surprises.
Cutting unintended and inefficient risk exposure is driving demand for more tailored books of trades to reflect a manager’s highest conviction ideas, which best reflect client’s desired exposure.
Crunching the data
Research from Cerulli Associates in the US found managers were broadening options to better meet client needs and objectives since 2008, which has seen separately managed accounts and fund-of-one structures increase in popularity. Their research shows that the managed accounts industry reached nearly $2.8trn in 2012, representing the fourth consecutive year of asset growth, and Cerulli project that the market will exceed $5trn in assets under management by the end of 2016 in the US alone.
The growing demand for more concentrated risk-taking through managed accounts is underpinned by another important evolution. The level of information investors are able to obtain, and their ability to make use of that data, has also increased. The importance of transparency in making informed decisions, particularly as they relate to risk management, has always been clear, but the tools to do that have not always been available.
Combining non-standard information from a large number of managers into a meaningful dataset at the portfolio level has traditionally been a significant challenge, making it difficult for many to manage risk properly.
“Traditionally, getting enough granularity in transparency from managers had been a big challenge,” says Alex Allen, senior portfolio manager with Sciens Alternative Investments. “Some managers had not been keen to provide that information, but investors can now get both transparency and homogeneity of reporting though the managed account route.”
Post-crisis managers now need to provide full transparency, driven by investor and regulatory demands. Transparency has therefore become a competitive advantage in a fiercely competitive world. Transparency is only as useful as an investor is able to digest and analyse the information, however. Demand for new technologies enabling investors to aggregate portfolio-level exposures and analyse their overall risk position has increased markedly.
State Street recently reported a threefold increase in the number of insurance clients during 2013 in its data-driven risk solutions. Their report showed 81% of 400 insurance executives intended to increase spending on data initiatives in the coming years as insurers’ risk management practices become increasingly reliant on data and analytics. The provision of aggregated portfolio level risk exposure has become a keen competitive factor for many funds of hedge funds struggling to survive their fall from grace.
Although Liongate arguably pioneered this approach in 2006 it has since become common practice and is being adopted beyond the hedge fund space.
The big picture
The apparent failure of diversification in 2008, which caught many investors by surprise, exposed the extent to which investors had failed to fully understand their risk exposures. The subsequent re-awakening of risk awareness is driving investors to seek more effective, holistic risk management. Taking a more holistic view allows investors to much more accurately pinpoint areas of concentration or bias within their overall portfolio, not just in terms of individual securities, regions or sectors, but also, and perhaps more importantly, at the risk factor level.
Blackrock’s Warwick says: “Using risk factors is a much better way of managing portfolio risk and spotting concentrations within those portfolios, some of which can be hedged.”
A survey by Deutsche Bank’s Global Prime Finance business shows that 41% of pension investment consultants recommended this approach to clients and 39% of investors are now embracing a risk-based approach to asset allocation, representing a 14% increase since 2013.
The Church Commissioners for England is one such institution. “We cut the data lots of ways to get a holistic view of the risk in the portfolio,” Joy says. The uptake of risk-based diversification is allowing investors to remove historical constraints on allocations to alternative strategies, for example, and re-group allocations based on common risk factors.
According to Joy: “We don’t think of alternatives as an asset class. Although equity long/ short is a hedge fund strategy, we have allocated to it within our public equity bucket because this is a defensive equity strategy.”
Diversification has given way to selectivity, changing how institutions allocate assets. The holistic view of risk afforded by better transparency and improved technology is leading a growing number of investors towards more concentrated, targeted portfolios using managed accounts in order to improve risk efficiency.
“In the past people have tended to over-diversify,” Joy continues.
“The crisis has made people look under the bonnet and gain a better understanding of their risk. Sophisticated investors are increasingly looking at things in terms of risk parameters not asset classes, which is a good thing.”
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