Issue: November/December 2005
Edutorials
Investec

THROUGH THE PORTFOLIO JIGSAW

Michael Streatfield, strategist at Investec Asset Management Michael Streatfield, strategist at Investec Asset Management, shows how trustees can benefit their funds by harvesting the best of scarce investment talent available.

Across the world, high-quality investment talent is in short supply. This is even more pronounced in a modestly-sized investment arena such as South Africa. By ‘investment talent’ I mean experienced portfolio managers with consistently-proven ability in their fields across market cycles, not the latest one-hit wonders.

As the retirement-fund industry moves from a balanced to a more specialist environment, there is greater opportunity to access the investment industry’s scarce talent. However, this is a challenge that requires new thinking by trustees in building their retirement-fund portfolios.

Traditionally, funds would decide on the investment management structure and then choose the people to manage the portfolios. The new paradigm requires this to be turned on its head.


Traditional approach to portfolio construction: Mandates first ...

  1. Choose structure

    • Equity/Bonds split
    • Mandate types



  2. Fill in boxes

    • Select managers for “job”



  3. Review structure

    • Balance overall portfolio



Instead, trustees should first seek out the rare talent -- no matter what the person is managing, whether it is a value fund or multi-asset absolute return portfolio -- and then gather these managers together for their fund. This cadre of proven ability in a specialist structure will sow the seeds for out-performance, no matter what the weather. Their experience can provide great comfort for trustees who are faced with increasing volatility in markets and business environments.

First harness talent, then look at structure

  1. Search for talent

    • Look for best



  2. Build into structure

    • Choose “alpha generators”



  3. Review structure

    • Balance overall portfolio
    • Address any gaps



This evolution is happening in the international markets as retirement-fund structures become more focused on finding talent. The 2004 annual search report of international investment consultancy Mercers shows increasing diversification as portfolios increasingly include hedge funds, international assets and specialist bond funds in their widening search for ‘alpha’ (better-than-market return for an asset class). Trustees are following ideas, unconstrained by the walls of their existing structures.

Looking beyond traditional structuring of mandates in the search for ‘alpha’ is having wider impacts. In the UK in 2004, some 26 percent of money placed in searches by investment consultancy Mercers was for currency overlays. These overlays look to boost overall return on the total portfolio by both adding a diversified element of return and more actively managing currency risk taken by investing offshore.

A criticism of the approach of focusing on people before structure is that the fund could be ‘skewed’ in a particular direction. This can be obviated at the fund level by reviewing the resulting portfolio of these skilled managers. If any large unintentional tilts are observed, then a final portfolio can be specifically constructed to close the gaps and balance the fund.

This is known as a ‘completion fund’. If you find the resulting mix of talent is too heavy on equities, for example, to balance the mix you simply add a traditional bond portfolio. It should not constrain your initial best choices. In this way, retirement-fund trustees will get the best out of their specialist structures.

We know the returns from talent are additive – out-performance of each component adds to the whole fund – so over the long run picking the best investment managers in the market will surely reward retirement-fund members.

Funds must harvest talent in this way, instead of rigidly being trapped into choosing the ‘boxes’ and then being left with mere scarecrows watching over barren fields.