By John L. Bowman, CFA; Senior Managing Director, CAIA Association.
I've lived a life that's full
I've travelled each and every highway
And more, much more than this
I did it my way
Channeling the iconic Frank Sinatra and his popular funeral accompaniment, we are here to declare the rise of a new epoch. Since the 1980s, inflation has experienced a 40-year hibernation brought on by accommodative monetary policy, supply chain globalization, labor union obsolescence, and highly adaptive and flexible labor categories. Many have argued that cheap capital has artificially smoothed economic cycles, provided a violent tailwind for capital market returns, and engendered a dangerous short-termism and gambling culture in the public markets. As “Ol Blue Eyes” purrs later in the song, “we’ve bit off more than we can chew,” and the music will eventually stop.
The CAIA Association advocates for a sustainable, long-term capital markets system that will improve investment and societal outcomes. There is strong evidence that professional and patient capital allocation serves to catalyze innovation, cultivate societal wealth, and ultimately contribute to more healthy and inclusive economic growth. As we return to a more normalized economic, inflationary, and financial climate, investment professionals would do well to keep a few key principles top of mind as they embark on constructing a portfolio for the future. We believe this portfolio will exhibit five distinct marks:
Responsible portfolio management consists of collating a series of uncorrelated beta and risk premia that offer a combination of income, inflation protection, capital preservation, and principal growth to meet a required return. Recent years have proliferated the unlikely narrative that financial assets, particularly public equities, eternally march upwards. This has led to a casino mentality where the latest Dutch tulip can simply be contrived through social network collusion or gamification of wealth management. Investors deserve better than this; investment professionals must warn and steward clients and beneficiaries more maturely. And that begins with a return of the foundational principle of diversification across asset classes, geography, sector, and purpose.
The traditional 60/40 public equities and fixed income allocation has provided extraordinarily well in the last decade. But the discerning investor knows history teaches us not to take solace in the recent past. Today’s composites of investment strategists predict future 60/40 returns at a mere 3-4% in the coming years. This falls well short of client expectations and actuarial requirements. Larry Fink, in Blackrock’s recent investor day, declared the 50/30/20 (20% “alternatives”) model the new normal. Investment professionals will have to look to other sources of return, notably private capital, to increase the potential of being able to fully meet their obligations.
Private capital has become increasingly attractive for earlier stage, new economy, growth companies. And, because it is detached from the short-term machinations of public markets, it liberates investors to take advantage of market dislocations, information asymmetry, and out of favor or countercyclical opportunities. Avoiding private capital in a portfolio strips access for clients to an increasingly large portion of the global economy. In the US alone there are now more companies owned by private equity than are listed on public stock exchanges. Of course, private markets are far from a silver bullet given their opacity, high fees, and wide risk-return dispersion, and therefore must be carefully considered in light of client liquidity, income needs, and risk tolerance. Extensive due diligence and thoughtful, deliberate manager selection is imperative.
Rooted in a Fiduciary Mindset
Investment management is an agency business. Asset managers exist to deliver trust, care, and expertise to clients. A fiduciary mindset begins with an existential understanding of purpose, alignment, and service to the client. Firm ownership, incentives, fee structure, talent recruiting, culture, and definition of success (benchmarks) must find their foundation in this purpose. The investment profession - and each client’s portfolio for the future - still has work to do in mitigating conflicts of interest, asymmetric payoffs, and unnecessary financial engineering.
The age of the universal owner has arrived. Clients are demanding both positive financial and social outcomes from their capital allocation and underlying holdings. With an assist from a devastating global pandemic, climate consciousness and the pursuit of clean energy alternatives are at a fever pitch. Investment professionals are integrating sustainability elements such as carbon footprint, diversity progress, human-rights record, and labor practices into their security evaluation, risk management, and return expectations. Further, non-financial disclosures as well as ESG ratings are becoming more accepted as a regular, integrated part of security analysis. The portfolio for the future will be much more insistent and proactive in ensuring that it contributes to a more inclusive and sustainable tomorrow.
Dependent on Operational Alpha
The modern investment profession is highly competitive. Persistent alpha based on information speed, intellect, or perceived edge is an elusive concept belonging in a museum. New sources of competitive advantage are becoming commonplace amongst enterprising professionals. Firm culture has shown to be much more predictive of sustained performance than previously thought, and is an emerging priority for any leader. Additionally, the explosion of artificial intelligence tools allows for patterns to be gleaned from large unstructured data sets and provides a fresh frontier of potential investment insights and operational efficiency. The portfolios for the future will be driven by firms that prioritize a healthy environment for team members to flourish and contribute, and calibrate the use of machine learning to save cost, reduce risk, and pioneer new investment ideas.
We are exploring these characteristics in greater depth as we work to develop research that can help reorient investment managers toward a north star of portfolio construction - one that prioritizes client and beneficiary outcomes and works tirelessly to achieve those outcomes in a long-term sustainable way.
About the Author
John Bowman, CFA serves as Senior Managing Director for the CAIA Association, overseeing the industry leading CAIA charter, the thought leadership and advocacy agenda, as well as stewarding CAIA’s Asia Pacific growth aspirations.
John has devoted 25 years to the asset management industry to recover the narrative of the value that the investment profession brings to society. He is a staunch public advocate for market integrity, long-termism, investor outcomes, diversity, human dignity and educational standards, as necessary ingredients to building a sustainable and healthy profession.
John previously served as Managing Director for the Americas for CFA Institute, a region comprised of 40+ countries from Canada, the U.S., Central America, South America and the Caribbean. Bowman joined CFA Institute in 2004 after holding several industry positions. He served as a portfolio manager at Mellon Growth Advisors (MGA), where he was responsible for portfolio construction and stock selection for the MGA International Growth and MGA Global Growth strategies. Bowman also served as a portfolio manager for the International Growth Opportunities Strategy at State Street Global Advisors (SSgA) in its Global Fundamental Strategies Group. Before moving into portfolio management at SSgA, he was an equity analyst focused on domestic and international telecom, technology, consumer products and retail.
John is a prolific writer and commentator, frequently appearing in industry and business publications such as the Wall Street Journal, The New York Times, Pension and Investments, Financial Advisor, The Independent, Wealthmanagement.com and CNBC.