Susan Gosling is the head of investments at MLC, the retail arm of NAB’s wealth management business, and a chief investment officer finalist in Conexus Financial’s Superannuation Awards 2015. She is responsible for MLC’s multi-asset portfolios, both the traditional diversified portfolios and their outcome based Inflation Plus strategies. She is particularly passionate about the Inflation Plus funds which have $1.1 billion funds under management and represent a new generation of diversified funds focused on delivering above inflation returns while limiting exposure to negative returns.
The investment approach Gosling has developed over the past 30 years is based on the simple foundation that the future is always uncertain and that forecasts are always unreliable. The future is not predetermined but dependent on complex dynamic factors which can interact in unpredictable ways. The most obvious evidence for this, she says, comes from the inability of forecasters to accurately predict economic growth or inflation other than a continuation of an existing trend. This makes it necessary to take into account that important things can and do change through time.
The strategy she adopts in response is to build an understanding of those important things that could change, and so put together a set of the most important possible futures or scenarios that could occur. This provides information about the things that can go right, and importantly what might go wrong.
According to Gosling risk is no longer simply a statistic (commonly standard deviation) but real economic events and investment circumstances that might occur. Looking forward from any point in time, the extent of risk that could occur depends on what’s priced into markets.
For example, higher equity prices imply greater complacency about potential risks and hence greater downside should those risk eventuate. Today, ultralow bond yields indicate that normally defensive nominal bonds are outright risky in many circumstances.
The power of this process, she says, lies in thinking through ahead of time what could happen. Its strength comes from the depth of information that it provides about both risk and the opportunity for diversification. These insights are essential for the Inflation Plus funds in particular. These funds require that risk is managed consistently through time.
Risk is the potential for negative returns – both the probability of negative real returns and the potential extent of those returns. By comprehensively mapping potential futures Gosling’s team is able to generate what is rare forward looking insight into these risks.
For the Inflation Plus funds this information is used to anticipate and control for what could happen. The objective is to bullet proof the portfolio by being ready for anything. Since the riskiness of all assets changes through time, in order to maintain risk control and still generate the returns that investors need, a very flexible asset allocation is required. The greater asset allocation flexibility of outcome based versus traditional diversified funds removes constraints and allows the generation of higher returns for a given level of risk.
“If you do stand back then you are in a different world that has a lens into the future and that’s what you need, mapping out the set of future uncertainties. It is very distinctive.”
Gosling published a paper in the Journal of Portfolio Management in 2010 detailing the philosophy of this approach and a number of organisations have since used the insights of the paper in developing their investment approach. However, Gosling cautions that there is a tendency to select a central scenario and have a number of variations around that. She sees that approach as flawed since it still overestimates the extent to which the future can be forecast. The point, she says, is to construct the distribution of outcomes and use the depth of information that provides.
The superannuation industry has tended to define multi-asset funds or diversified funds by their mix of debt and equities on the implicit assumption that if you hold that mix through market ups and downs it will eventually be OK and returns will be generated.
The trouble is that assumption is based on the benign investment experience of the ‘80s and ‘90s which was a very unusual, extremely positive investment era coming off the 1970s which had been disastrous for savers.
“You had a starting point that was particularly fortuitous as central banks came to grips with their inflation control strategies. Investors had this massive disinflationary tailwind for debt and equity markets. You did have some ups and downs, but all you had to do was hold onto your strategy. That I think is why traditional diversified funds developed as they did, and why active asset allocation went out of fashion for so long.”
There is now a much broader understanding that this traditional approach can’t necessarily be relied upon to deliver over time horizons that are relevant to investors, particularly when they are in their retirement phase. Drawing money down each year can result in some serious sequencing risks that affects lifestyle, permanently.
Hence, Gosling’s motivation for funds, rather than relying on a mix of debt and equity, to understand that the risk profile of all assets changes quite significantly over time. The Inflation Plus funds are seeking to maintain consistent risk exposure over time, protecting the investor from issues of sequencing risk, and giving the ‘sleep at night’ factor back.
There are three inflation plus funds with three different time horizons (three, five and seven years) and each has an asset allocation that responds dynamically to changes in the investment opportunity set.
“We have a process that looks forward. The measures of returns potential, risk and diversification are all forward looking, which is unusual.”
The Inflation Plus funds are not looking to beat the benchmark, rather they are looking to invest to get a sustainable outcome. And that goes for the way in stocks are selected as well as asset allocation. Gosling‘s team is working to get all dimensions of the portfolio aligned to the outcomes investors require. Gosling says that they do not want to hold stocks simply because they are part of the benchmark, but only if they can get the result that she wants, specifically a level of robustness.
This philosophy goes right through the portfolio from asset allocation through to stock picking.
This holding of a consistent risk profile, thereby controlling risk consistently for investors to limit the downside, means there is a need to understand what futures or uncertainties are being faced, how large they are and what are the specific sources.
“That’s a way you can generate robust outcomes if you do that thoroughly and systematically, so you’re capturing that range of distinctive futures, then you’ve got a really powerfully tool.”
Typical investment approaches don’t do this because everyone is prone to common behavioural foibles, particularly overconfidence – a belief that if you do enough work you can forecast the future that is going to unfold. Common behavioural foibles include confirmation bias, where you are searching for information that supports your view which tends to result in contrary information being ignored. These biases are innate. Difficult to avoid other than through a very carefully designed and deliberate investment structure.
“This stops investors from thinking about futures that are significantly different from what we are currently experiencing or significantly different from what the consensus is.”
That’s a problem.
For example, these behavioural biases resulted in the perception that we were in a low risk environment prior to the global financial crisis, the great moderation, when if you looked a little bit below the surface at the time it was clear that risk was high.
As such Gosling advocates a need to step away from those behavioural biases and recognise that important things can and do change. The most important point, she says, is relying on one particular forecast is always unreliable, no matter how much work you do, how clever you are, or how sophisticated your tools.
“When the past is looked at it’s post-rationalised to death. We tend to think, ‘That was inevitable, how could I have picked it?’ But it wasn’t inevitable at all, just one of a large range of a possible sequence of events that might have happened. It could have been very different. We think the past is pre-determined so the future must be, and if it’s predetermined it must be forecastable. They’re all mistaken beliefs.”
Gosling says the biggest challenge with inflation plus is not the investment, it’s the communication. Funds that give smoother ride avoid the big draw downs but don’t participate as much in the strong positive returns either, and keeping people on board in those strong times, like now, can be very hard.
“There’s this perennial risk that investors will be watching other top performing funds and switch just at the wrong time having not got all the upside and then getting the full downside.”
Inflation plus customers are largely retail, with some from the smaller corporates and high net worth individuals and while they haven’t yet targeted the institutional marketplace there is a plan to do so.
A quibble over risk
Gosling’s focus on risk rather than returns bears similarities in philosophy to Damian Graham of State Super Financial Services.
According to her, and consistent with her approach, volatility is not a good indicator of the risks that matter to investors, negative returns are what hurt.
In her assessment risk is real events, things going wrong, maybe an inflation shock or a policy shock or a growth shock or a geopolitical event – not volatility.
“Volatility is a summary measure of risk which misses a lot of information and is disconnected from the real world of investors needs and vulnerabilities. It’s a very blunt measure and hides an awful lot of detail, and you really need the detail if you are going to control risk efficiently.”
Gosling focuses on the probability of a negative real return over a time horizon defined, and more importantly the extent of that negative return, but she goes further than that.
“Our distribution is made up of scenarios we have specified. We look at every individual scenario, 55 in total, and say if this scenario occurs is this outcome acceptable? And if it’s not then we have to do something about that. This is where the bullet proofing comes in.”
Head of Investments MLC
Treasurer at Taldumande Youth Services Inc – 6 years
Chief investment officer Advance Asset Management
Chief investment officer United Funds Management
Director United Funds Management
Director Australian Investment Managers Association
Economics BSC, MA, PhD, London University
Chief investment officer of the year, Conexus Financial Superannuation Awards 2015
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