Executive summary:
- A robust implementation strategy and real-world implementation capabilities are both necessary in order to achieve your portfolio’s preferred position.
- We believe that a best-practices OCIO provider will have strong capabilities in implementing manager transitions, efficiently changing manager weights, and deploying precise positioning strategies.
- We believe that expertise in trading both physical securities and derivatives in real-time is a requirement when using these strategies.
Editor's note: This is the third article in a three-part series: Know what you own; Know where you want to be; Know how to get there.
Your portfolio needs to move. You know where you want to go. But how do you get from point A to point B?
Let’s assume you’ve done the work to know where you want to be. You’ve decided on the asset-class shifts and the revised underlying asset-class structures. Maybe you’ve even researched specific investment manager products and selected the actual managers. If you do all this well, you have a best-laid plan, right? What could go awry?
For part three of this blog post series, we’ll talk about the fact that many genius investment strategies have failed because of poor implementation. In order to get where you want to go requires not just a great implementation strategy, but also requires real-world implementation capabilities.
At Russell Investments, we believe best-practice asset managers need capabilities in manager research, trading, transition management, overlays, currency, and precise positioning strategies. At a higher level, we think in terms of three main implementation levers, ranging from broad to precise:
- Swapping out money managers
- Adjusting manager weights
- Precise positioning strategies
Movable money managers
Let’s say that a money manager assigned to a portfolio needs to be replaced. Perhaps they are not executing their investment process as expected, or there has been turnover on the investment team that concerns you, or you simply have to make room for a higher conviction manager.
Once you’ve completed the hard work to identify the replacement, real-world considerations of how to actually transition assets come into focus. This can be a complex process depending on the country's domiciles, regulatory environment, currency considerations, and liquidity associated with the incoming and outgoing managers. For an asset manager without the right capabilities, this process can be fraught with opportunities for inefficiency, unwanted tax events, and loss of market exposure. To do this well requires transition management expertise. A skilled transition management team can make this process highly efficient and minimize opportunity costs. How do you know if your transition management team has your best interests in mind? At a minimum, be sure the provider you choose fully discloses their fees and provides complete transparency, particularly while the event is in process.
Manager weight adjustments
Replacing a manager is a significant action. Instead of swapping out a manager completely, we more typically look at moving exposures from one manager to another depending on the risks and tactical opportunities we observe across our entire opportunity set. For example, as we talked about in our last article, in the early months of the pandemic, value stocks were underperforming the broader market due to the economic slowdown triggered by government lockdowns. But we knew from our cycle, valuation, and sentiment (CVS) investing framework that the value factor often performs best coming out of recessions, and that the valuation characteristics of value stocks were far below normal. So, we increased our exposure to value managers because we knew where we wanted to be. And sure enough, when COVID-19 vaccines were announced in November 2020, the value went on a tear, outperforming the broader global equity index by over 20% from November 2020 to early 2022.
But whenever exposure changes are made, there are still inefficiencies to be avoided. Trading expertise is vital. For maximum trade efficiencies, we believe trading expertise should be held to a high bar, with the following best-practice characteristics:
- 24-hour staffing – When global markets are open, the trading desk should be open. Even with international exposure instruments that can be executed during U.S. trading hours, like futures and ETFs, large institutional investors need local market access to manage real-time risk with minimal trading costs.
- A pure agency model – The structure of an agency model removes potential conflicts of interest. The structure itself demands that the trading desk works on behalf of the client, not on behalf of the asset manager. By its nature, it eliminates conflicts associated with proprietary books.
- Specialization – Markets are complex and understanding the nuances of individual asset classes is vital. We believe traders should be organized to specialize by asset class, including fixed income, equities, derivatives, and foreign exchange transactions.
Precision through positioning strategies
When it comes to the fine-tuning of a portfolio, we also recommend using internal positioning strategies separate from money managers, as this allows for greater precision, speed, and flexibility in achieving your dynamic preferred positioning. Positioning strategies may include derivative-based overlays or custom-built quantitative strategies.
As an example of how this can work in a global equity portfolio, consider a situation where more exposure to Japanese equity is desired relative to the existing country exposure in a portfolio. However, we often find that active managers are chronically underweight in Japanese equities. In this case, a portfolio manager may use a positioning strategy, such as a futures overlay, to bring the entire portfolio’s exposure to Japan in line with their preferred positioning. Additionally, depending on the hedging strategy desired in the portfolio, a positioning strategy can also include currency forward contracts to disentangle the Japan equity exposure from the Yen currency exposure. Taken together, positioning strategies are custom-designed to ensure that a portfolio’s position is fine-tuned to improve both the risk and return profile of a portfolio, often with a focus on reducing downside risk. But to do this well, we believe expertise in trading both physical securities and derivatives in real-time is a requirement.
Completing the circle
As we’ve shown here, we clearly believe that a best-practice asset manager will have a robust capability set, including open-architecture money managers and skills in transition management, trading, and derivatives.
Here’s the catch: Investing this comprehensively requires a clear view of a total portfolio at any given moment. This is why it is so important—so necessary—to know what you own, which takes us back to the first article in this series. And thus the cycle starts again.
Disclosures
These views are subject to change at any time based on market or other conditions and are current as of the date at the top of the page. The information, analysis, and opinions expressed herein are for general information only and are not intended to provide specific advice or recommendations for any individual or entity.
This material is not an offer, solicitation, or recommendation to purchase any security.
Forecasting represents predictions of market prices and/or volume patterns utilizing varying analytical data. It is not representative of a projection of the stock market, or of any specific investment.
Nothing contained in this material is intended to constitute legal, tax, securities, or investment advice, nor an opinion regarding the appropriateness of any investment. The general information contained in this publication should not be acted upon without obtaining specific legal, tax, and investment advice from a licensed professional.
Please remember that all investments carry some level of risk, including the potential loss of the principal invested. They do not typically grow at an even rate of return and may experience negative growth. As with any type of portfolio structuring, attempting to reduce risk and increase return could, at certain times, unintentionally reduce returns.
The information, analysis, and opinions expressed herein are for general information only and are not intended to provide specific advice or recommendations for any individual entity.
Frank Russell Company is the owner of the Russell trademarks contained in this material and all trademark rights related to the Russell trademarks, which the members of the Russell Investments group of companies are permitted to use under license from Frank Russell Company. The members of the Russell Investments group of companies are not affiliated in any manner with Frank Russell Company or any entity operating under the "FTSE RUSSELL" brand.
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