Portfolio complexity can hurt performance and culture
Reducing complexity in a portfolio can add to financial performance and also helps investors attract talent.
HESTA Super Fund investment committee chair Mark Burgess explained to an audience at the Fiduciary Investors Symposium in the Blue Mountains in May that if asset owners don’t create techniques to clean up a portfolio, which might include having a whole-of-portfolio approach, they might retain complexity at a great price.
“There are lots of investment reasons [to reduce complexity] but also, if you can attract staff into a clean and simple portfolio, you’ll get better people,” Burgess said. “If you allow bad people into the organisation, over time you’ll lose your culture.
“Some of your best talent can spend weeks trying to fix up a complex problem and just think of what that does to your culture. If you create a portfolio that’s hard to manage and your leadership moves on, you can’t attract good people because they don’t want to take on legacy business.”
Burgess added that asset managers are enormously incentivised to create complexity in a low-return world.
“The more complex it is, the more they can charge,” Burgess said. “But there are also lots of people trying to find a niche and so they’re coming to you with the overlay of complexity because it’s in their best interest. Even index fund managers will try to slip in a complex index fund or factor investment that lifts that fee rate to get the margin. What they’re doing is creating complexity and you have to be aware of it.”
Morningstar Investment Management chief investment officer, Asia-Pacific, Andrew Lill, said to help simplify a portfolio it’s important to know what your investments are trying to achieve and how to articulate them.
“We’re really concerned with total portfolio risk – holistic risk,” Lill said. “As soon as you start siloing and parcelling up risk, you lose control. Everything has to be thought about in the overall portfolio context.
“We think simplistically: what are the key attributes of our portfolio? I think for most Australian investors [asking] ‘What’s your allocation to equity beta? What’s your allocation to duration or rates? What’s your allocation to currency risk?’ is a really good place to start.
“Then think about how that portfolio is going to act in certain scenarios – growth higher than expected, growth lower than expected, inflation higher than expected, inflation lower than expected – the four-quadrant model.”
Lill said working out how a portfolio performs in this way lets an investment team focus on opportunities.
Head of Asia-Pacific portfolio management at Dimensional Australia, Bhanu Singh, added that the structure of an organisation influences the level of complexity in a business.
“We have a single investment philosophy that permeates all of our investments,” Singh said. “The framework we use around the globe makes it easy to have conversations. We know what our portfolios are designed to do. So, to monitor them becomes easy and setting up governance structures around those portfolios is straightforward.”