Arthur: The problem is when we look at and analyse a fund manager’s performance, we want to cover the tail risk but we’re not giving the asset manager a long enough time to be able to show they can do that. So if you put 20% of your fund in cash, you can guarantee if markets don’t collapse within two or three quarters, your client base is going to begin turning the wick up and giving you a hard time, so it’s very difficult from an institutional asset owner’s point of view to feel comfortable making that sort of move and so you’ve got to look at other ways of addressing it and that comes back to the diversification.
Pendock: If you ask any fund manager the definition of risk they’ll say it’s the permanent loss or impairment of capital, but their actual risk is being more than 3% behind the benchmark, because then they could lose their home and their mortgage and their marriage. That’s more immediate. We’ve just been through the global equity turning process; we had 57 manager meetings and we discussed a lot with managers this concept of looking at volatility relative to the benchmark and whether you look at risk in absolute or relative terms. Fund managers come out with attributions saying, “Our biggest loss was something we didn’t own” and it doesn’t really make sense and that’s distorting people’s view of risk as well as the fact that the price of risk has been distorted by central banks.
Lindenberg: We do have a regulatory structure which encourages a very short-term focus; you’ve got quarterly investment committee meetings, interrogating the manager if he’s 1% or 2% below the benchmark. If you’re a pension fund you have a tri-annual valuation where you have to report the funding position, but I take the view that you’re looking to identify risk premia that you believe will deliver a return over the long term. It’s not really the role of a trustee board to be taking tactical positions around performance of specific markets over a short time horizon; that’s something that is better delegated to a qualified third-party.
Cantara: The view over a full market cycle on average is not three years; it’s some multiple of that, but it has a range around that as long as 12 years, but it’s still a full market cycle. So, are you performing the way you’re supposed to be performing in that part of the cycle? That’s an area as a manager we try to spend a lot of time setting expectations. No, we’re not going to outperform every quarter and if we do, you should probably fire us because we’re doing something that is inconsistent with our overall stated philosophy. If you looked at three year rolling periods over a 30-year timeframe, Berkshire Hathaway would have underperformed the S&P 36% of the time. So, even Warren Buffett underperforms in short periods. We need to stretch that time horizon out which goes against a lot of the regulatory or the mandated view periods, but it’s a discussion between asset owners, asset managers and trustees, to really understand, “What is the timeframe that we should be using?”
How do fund managers square their need to outperform with clients’ need to manage volatility?
Pendock: When we go with fund managers we want to make sure these are people we can say are strategic partners and like any partnership, there will be tough times as well as good times. So that relationship has to be there and is better for fund managers because the cost of acquisition is higher.
Arthur: We are definitely seeing a move back to broader mandates; that requires a better level of reporting from the asset manager and a greater level of trust and communication. Our industry has not been brilliant on the trust side and we have to work very hard at developing that.
Pendock: When the best fund managers talk about their companies, the models they build are the quantitative expression of the sum total of the knowledge about the company and they’ll talk about the management, the management team, how this has changed and how that has changed. That is happy days when we get the alignment all the way through.
Lindenberg: There’s a growing recognition in the industry that the wider strategic asset allocation decision is the biggest driver of results, rather than selection of the best product. So it’s not so much, “Has the manager beaten the benchmark?” but, “Is the benchmark itself the right structure for that scheme?” and have you selected a manager who can fulfil the wider principles and objectives that you’ve set at the overall strategy level?
Cantara: That element of understanding the culture of an organisation is much more sustainable than just viewing past performance. Alignment in terms of time horizon, resources and sharing of information, certainly come in to play as well. That gives the asset manager and the asset owner, a much better chance to succeed. I do see that happening globally a lot more than ever before. That’s quite a different conversation than five years ago, 10 years ago, when it was much more transactional in nature. To bring this back to the volatility point again, a big focus for us is winning by not losing. So, some of this is not just about finding the name that’s going to provide all of the returns, but really it is about avoiding those which might in the future be referred to as mistakes. In setting expectations, that means in some markets that is not going to keep pace with a cyclical upturn, but in other instances you see that quality come through.
Pendock: There’s not investing in companies which are going to be disrupted but then there’s the mathematical asymmetry of something falling 50%; it’s got to double to get that back – people forget that.
Cantara: That’s critical; we don’t have to necessarily exceed in the up-markets, but as long as we can protect investor capital in the down markets and continue that compounding, that over the long term certainly is a winning strategy.
