For many advisers and SMSF investors, active management is typically thought of as a portfolio manager’s ability at picking stocks, or a multi-asset manager’s ability to forecast asset class performance ahead of time and tilt portfolios accordingly.
In fact, most of the cost of running active management strategies are the teams of economists, consultants, quantitative programmers, strategists, and analysts to do the above functions. With a strong correlation between funds under management (FUM) and size of global teams, one can understand the common belief system in our industry and how the traditional active asset management industry has developed.
If asset management were only that easy!
Unfortunately, most active management teams have not outperformed passive benchmarks, creating an industry super trend over recent years for passive investment allocations and lower management fees.
Turning tide?
With the massive degree of flow from active management to passive investing over the years, a list of growing concerns regarding passive investment is currently being debated. Clearly, growing risks of overcrowding is a concern, but more critically the disruption within the purpose of the stock market is called into question.
The stock market is meant to award stock valuation to the highest return on invested capital, yet market cap indices reward the largest capitalised companies without regard to quality (smarter beta indices aim to correct these issues).
More importantly, in a world where zero rates, and government interventions continually reinforce a powerful momentum into the largest capitalised stocks, a question arises: what happens if this positive feedback loop turns negative? Or money flow returns to a more efficient asset allocation process.?
Active risk management, capital protection, and a real rate of return
As a case study, an alternative approach to active management is outlined in Melbourne-based Cor Capital’s approach to portfolio construction and their nimble rebalancing of the portfolio.
Contrary to the largest asset managers in the world, Cor Capital’s approach believes there is little evidence in the ability for multi-asset teams to beat market returns from forecasting and making asset class calls consistently.
Instead, a more robust approach to portfolio construction is in the preparation for all environments and the likelihood of any manner of unexpected surprises. An approach that focuses upon diversification of fundamental risk and active rebalancing provides a more sound portfolio built for real absolute return especially in an increasingly uncertain world.
For investors seeking core portfolio needs of capital protection, delivery of a “real rate” of return and a more asymmetric exposure to risk assets, Cor Capital’s approach is designed to participate in any environment, especially as volatility increases.
Globally, as zero interest rate policies (ZIRP) for government bonds are supporting asset prices, advisers and SMSF investors are placed in a challenging position to maintain a core portfolio allocation that can provide, at a minimum; a real rate of return without outsized risk.
Importantly, traditional approaches of increasing growth exposure to meet return targets or reducing exposure to be more defensive come with their own risks of increased capital loss or loss of purchasing power.
Instead, active risk management and rebalancing a purposely built portfolio that is fundamentally diversified for all environments, while non-traditional; provides a more robust solution not tied to the guesswork of what might happen.
Critically, as threats of potential inflation and loss of purchasing power grow given the unprecedented levels of central bank liquidity; investors within traditional allocations find their portfolios ill-prepared for inflation.
For Cor Capital, portfolio construction for all environments includes a healthy allocation to physical precious metals (physical gold and silver) that provides protection for inflationary periods and maintaining a real return objective.
Source: Cor Capital All Environment Asset Allocation
Historically, while gold has been an attractive hedge for inflationary periods and currency debasement; it is further utilised by the team at Cor Capital as a counterweight to the portfolio exposure to equity assets.
With an active risk management strategy focused upon continual rebalancing, the portfolio can take advantage of the movement between these counterweights as an added source of alternative return.
As the markets brace for expected growth in uncertainty and risk, core holdings need to be set for surprise with an ability to participate in whatever develops. One would feel pity for the large global asset managers faced with the impossible task of making the right bets in this environment, until you understand how much they get paid for their guesswork.
Michael Armitage, principal and investment specialist, Fundlab Strategic Consulting P/L
