MLC chief investment officer Jonathan Armitage, a Conexus Financial Superannuation Awards nominee for CIO of the Year, talks adjusting to volatility and balancing risk with opportunity.
Investment Magazine: What was your greatest success in 2018 and was your most challenging moment of 2018?
Jonathan Armitage: This continues to be a challenging investment environment; however, there has been a shift in behaviour over the last year. We have been challenged by the conundrum of ever-rising asset prices but shrinking return potential and rising risk.
But over the last year, the fragilities in the global investment environment have become more evident, making it easier for investors to understand our defensive positioning. One of the greatest successes continues to be the stability and continuity of our investment teams.
IM: Market volatility may mean a higher probability of negative returns in the next few years. How will you meet the challenge of explaining this to members?
JA: Risk has been progressively rising as markets have, over the last six to seven years, delivered returns well in excess of long-term averages. We have been explaining to clients that a key driver lies in ultra-accommodative monetary policy and that to the extent that these policy settings are not sustainable, market valuations may not be sustainable.
With monetary policy now reversing, we are unsurprised to see a rise in market volatility. Over time, we have been preparing investors for this possibility. However, communicating clearly and effectively, particularly about the nature of risk, perhaps remains our industry’s biggest challenge.
IM: What risk metrics are being reported to asset owners and what would you like to see reported as an owner/investor?
JA: We would like to see more considered views on probability of permanent capital impairment. The ability to generate real wealth over the long term is most important. However, risk metrics focusing on shorter-term quantitative measures such as volatility contribute little towards managing real future risk in such an uncertain world.
IM: How can bias be removed at the committee level? Is diversification on the committee the answer?
JA: Firstly, by defining the ideal cocktail of skills, experience and psychological characteristics that is most conducive to a committee being outstanding in achieving its goals.
Secondly, by assessing the biases and capabilities of the existing committee. These biases could be investment related (a belief in simplicity over complexity), timeframe related (short-term vs long-term focus) or due to breadth of skills and experience (gender, age, roles, industry experience,
personal interests, etc). This skills audit can then be assessed against the ideal skills profile to determine how to improve the committee.
Thirdly, by recognising that even a committee with diverse, complementary skills and the right psychological tendencies will still be subject to common behavioural biases. It’s valuable to incorporate processes to lean against these biases. For example, one common behavioural bias is myopia – the tendency to focus disproportionately on short-term events and performance.
One simple process to lean against this tendency is to report performance with the longest period first; that is, start with 10-year, then five-year…so that quarterly performance is the last number the eye sees, rather than the first.
IM: Performance vs fees – why are we so focused on fees when performance is what the member wants?
JA: There are a number of potential points here. Lower fees are a known benefit and an easy sell. Identifying alpha is hard and, therefore, a much tougher sell. There can be an element of career risk also, where an investment paper proposing a fee reduction is captured as an immediate win, with performance consequences unknown for some time.
Continual fee focus is healthy. However, it should not be at the expense of long-term performance or risk management.
The low volatility and strong absolute returns of markets over the last 10 years have offered less opportunity for active management to demonstrate value. This has led some to extrapolate the past and question the value of active management.
A difficult investment environment will highlight skilful managers and remind many of the value such skill can add.
IM: What are your expectations for 2019, given the release of commissioner Kenneth Hayne’s final report in February?
JA: Our expectation for 2019 is primarily focused on potential market outcomes and the opportunities to generate returns in a sufficiently risk-controlled manner. We see the potential for a clearer regime shift to emerge in a more limited liquidity environment, with ongoing consequences for volatility and returns.
While it is not impossible that markets have moved to a permanently higher level of valuations, this is not the only possibility we need to take into account. History and our experience teach us that significant valuation shifts (or new paradigms) are rarely sustainable. The challenge is to work out what the right trade-off is between protecting investors against capital losses and harvesting returns now. We have an ongoing debate about where the right balance lies. Our focus for 2019 is on working out the possibilities.
The 2019 Conexus Financial Superannuation Awards are sponsored by event partner AIA Australia. All the winners will be announced at a black-tie event on February 28, 2018 at the Ivy Ballroom, Sydney. Tickets now available, visit conexussuperawards.com.au