An environment of low prospective investment returns and relatively high volatility demands more refined, “outcome-oriented” investment solutions, according to the global chief investment officer of Russell Investments, Pete Gunning.
Institutional investors and financial planning firms, Gunning says, need to have at their disposal a far wider range of investment options – “componentry”, in Russell’s terms – to implement investment solutions designed to meet clearly articulated investment objectives.
Gunning says the outcome-oriented approach is a natural evolution of the move from the original balanced-fund concept, where one institution managed all asset classes, to multi-asset solutions, where “best-of-breed” managers in individual asset classes were combined into portfolios.
Gunning says the new approach enables faster responses to changing market conditions.
“You could argue that even in the old balanced world there was the ability to do TAA [tactical asset allocation] or something like that over the top,” he says.
“But if you think about the portfolios of the late 1980s, the componentry was fairly constrained. You had domestic equities, international equities, domestic bonds, international bonds and maybe some property.
“We would argue now that the componentry within a really robust multi-asset solution includes everything from equities and then subcomponents of that – value, growth, defensive, dynamic, small-cap, large-cap – and the opportunity within fixed income includes sovereigns, high-yield, emerging-market debt, et cetera, adding in commodities, infrastructure, hedge funds, real estate both listed and private. So there’s more componentry there.
“More dynamic is how I would describe it. Still the best of the open-architecture approach, but more dynamic in terms of being able to respond to relative valuations.”
Gunning says there is “a general trend – not just, quite frankly, in Australia, but across the board – for more outcome-oriented solutions”.
“We work with the client to set up the asset allocation – for want of a better word – that will best meet the outcome that they want,” Gunning says.
“I think about it as, we understand what their outcome is, and we have the ability to dynamically manage the componentry in real time, as opposed to a consulting relationship, where we make recommendations. Part of it is implementation, and really, again, getting back to this low-return environment, a great strategy that’s poorly implemented is a great strategy wasted, so having the ability to implement more effectively just gives the client better outcomes.
“They know the individual clients, so really the transmission mechanism there – as we’ve done with Matrix – is we build some broad strategies and ultimately it’s up to the alliance partner to understand the nuances of the individual and then allocate them into the appropriate strategies. For us, it’s more B2B than B2C – we need to have a holistic view of the total portfolio we’re managing; they need to have a holistic view of all of the client’s circumstances to work out what’s best for them.”
The process in steps
The first step is for the investor – either themselves or in conjunction with their financial planner – to know and be able to articulate an achievable outcome. It might be a dollar amount of income, it might be an inflation-plus target or it might be a percentage-return target.
“When I think about the outcomes that our clients are specifying, I can think of each of those being a particular outcome they want,” Gunning says.
“The challenge is that they may want $60,000 a year, but if they don’t have the capital base to support it, we can’t weave magic. It’s either us or, in this case the financial planner network, really understanding the personal circumstances of the individual.
“But, they’re all outcomes. ‘I want $60,000’; ‘I want equity-like returns with lower-than-equity-type risk’; ‘I want 8 per cent’. Again, we’ve got to be operating with the realms of the achievable, but they’re all outcomes.”
“It’s actually more often than not a combination of a certain return, a certain tolerance for risk, a tolerance for different types of risk. So it’s not just the bog-standard volatility, because we know that upside volatility most people are fine with, it’s the downside capture that’s the problem. So it’s an understanding of how to work through they type of risk.”
“Some of them are not even alpha or excess-return targets. In the US at the moment, for instance, a lot of the defined-benefit funds we’re dealing with, they don’t overly care about excess returns. All they care about is they used to have a fully funded pension plan, it’s become unfunded, they’re writing a big cheque to fund it because of US GAAP accounting laws, so their definition of success is getting back to fully funded. So that’s a different outcome.
“It’s the same for retirement.”