Issue: September/October 2005
Edutorials
Investec

THROUGH THE PORTFOLIO JIGSAW

Michael Streatfield, strategist at Investec Asset Management What’s meant by ‘investment management structure’ and why’s it important for trustees to understand? Michael Streatfield, strategist at Investec Asset Management, offers an easy guide.

. . . ETFs. Long-only absolute-return funds. Traditional long-only mandates. Enhanced passive. Active quants. Market-neutral hedge Funds. Boutique satellites . . .

Trustees are faced with ever-increasing complexity when putting together their investment portfolios. Spoilt for choice? Or just plain confusing?

The investment management structure (IMS) is the way in which funds organise their portfolio of assets. These structures can be as simple as a single in-house investment team, or as complex as a large pension fund employing numbers of external organisations to invest some or all of their assets.

Trustees have been used to worrying mainly about manager selection – choosing who will run the money. Now, with more options available, they need think more seriously about IMS – the ‘what’ before the ‘whom’ of manager selection.

To do this, it helps to break down the portfolio into layers of manager types. It’s like a plate of food where vegetables, meat and potatoes each perform a specific nutritional job in providing a healthy diet. Manager types each do different things for an investment portfolio.

Layers within an Investment Management Structure

red Alternatives/ Hedge Funds
cyan Higher Risk Satellites
green Traditional Active Core (Balanced or Specialist)
pink Enhanced Index
purple Passive

Let’s explore these layers and look at what you get and give up for each:

purple Passive managers believe that investors cannot beat the markets. They aim to create a portfolio that closely mirrors a market index. Although these are low cost, they provide a return below that of the index after costs. So the next layer (below) is more efficient and more widely used in the South African marketplace.

pink Enhanced index managers track an index closely but take small bets to generate small returns to pay their way. This manager type can form a low-cost core to provide stable returns around an asset class such as equities. Investors get predictability, but they cannot expect much outperformance.

green Traditional active core managers – the arena in which South African trustees are most experienced – believe in active asset management. They take a modest amount of risk to generate returns for investors and provide a high level of comfort to trustees. Normal ‘balanced’ funds fall into this category.

Of late, we’ve seen a move to ‘specialisation’. Instead of choosing asset managers and letting them decide in a balanced mandate whether to invest in equities, bonds and cash, trustees select specific (‘specialist’) managers for each asset class. Once a retirement fund ‘goes specialist’, the trustees become a lot more exposed to what’s available.

cyan Higher risk satellite managers take on substantially more risk in offering higher performance. Here, trustees should tread carefully as they are in less familiar territory. It’s where unconstrained investment approaches – such as strong Style (value v growth) and sector fund portfolios – can be found. Individually they can be a bit of a rollercoaster ride. But if the managers have skill and are doing different things, then the blend can achieve a layer of high performance.

red Alternative-asset managers offer diversification from traditional approaches but normally require longer-term investing commitment. Fervent entrants in this category are real estate, private equity and hedge funds. On this part of the portfolio, investors should be prepared to sacrifice liquidity for the whole fund’s greater protection on the whole fund.

This manager type is generally driven by absolute returns (ie, less concerned with following markets than with losing money). Absolute-return strategies do offer some protection from market risk. Retirement funds must deliver for their members no matter what the market conditions.

scheme A
A) Traditional Two Traditional balanced managers.
scheme B
B) Specialisation Exploring different manager types within an asset class. 
1 Traditional Fixed Income Manager. 
3 Equity Managers of different risk levels.
scheme C
C) Complex Exploring different manager types. 
Hedge Funds. 
3 Blended High Risk managers. 
2 Traditional Managers and Low Risk Core.

CHANGE MANAGEMENT

In a specialist IMS framework, funds have more choices. How do they change allocations to different asset classes as markets shift? For example, if trustees are worried about equity-market risk they might want to give more to their bond manager and less to their high-risk equity manager.

There are basically two approaches. One is to choose a tactical asset allocation specialist manager who will allocate amongst managers to adjust asset-class exposure. Another is to have some higher risk managers who are unconstrained; a fund, such as an absolute-return fund, allows its portfolio manager to respond to market developments.


Building retirement fund portfolios

With the South African marketplace moving toward greater specialisation, trustees will be exposed to more types of investment managers. The diagrams illustrate the movement of funds from A (where they may have chosen two or more ‘balanced managers’) to B (specialist structures where they’ve chosen best-of-breed managers for a specific job, such as equities, in the portfolio). This might involve looking at less familiar managers doing unique things at different risk levels. It can expose trustees to new investment approaches and manager types.

As our marketplace develops, the burgeoning hedgefund industry indicates that some of the bigger retirement funds may evolve to even more complex structures. Several megafunds already have.

An asset-management firm can offer various funds across all manager types. Larger firms usually have wider product ranges with different risk profiles. Trustees should feel comfortable in choosing not only with whom they’re investing (the asset manager) but also with what they’re buying (the fund/mandate on offer).