Asset management and sport share some common principles: both portfolio managers and sports team managers alike strive to select the best, whether it be investments or players, to achieve superior performance.
Just as each investment serves a specific role in a portfolio, akin to players in a team, good investment management requires positioning players where they perform best.
While traditional asset managers typically allocate assets such as equities, bonds and alternatives to specific positions analogous to attack, midfield and defence, achieving true diversification remains a challenge due to benchmark constraints and the narrow player set available.
Homogenous outcomes from traditional managers cause a diversification dilemma for many advisers, but this dilemma can be addressed through alternative options such as derivatives.
Three scenarios
Access to derivatives markets broadens the set of “players” and tactics that can be used to build portfolios and provide differentiated outcomes for advisers. Three unique players that are specific to derivatives markets are defined return investments, pure inflation investments and volatility-based investments. When used in a multi-asset framework, these players form part of the attack, midfield and defence, respectively.
Defined return investments provide a maximum of three scenarios: capital return plus positive return, capital return only, and capital loss. Capital loss generally occurs if developed equity markets are down more than 35 per cent at the end of a six-year period.
If markets are down between 25 per cent and 35 per cent at the end of six years, largely only capital will be returned. These scenarios are conducive of bleak equity market conditions — in all other scenarios, the positive return is paid.
The positive return is typically 7-8 per cent (net) annualised, which is not dissimilar to long-run equity market returns, and we consider this a “good” return, rather than a “great” return.
In exchange for a good return, the possibility of a greater return is given up — after all, perfection is the enemy of good.
The differentiated outcome defined return investments provide makes them a unique attacker when used as part of a wider portfolio. They are designed to score more consistently while offering some help in defence.
Traditional equity attackers may occasionally score more, but they tend to be less consistent and struggle to help out in defence. The combination of a traditional equity allocation alongside defined return investments should lead to greater diversification, more predictability, and an increased probability of positive returns from an equity allocation.
Good management is not just about picking the best players that gel well, it is also about tactics. Bonds tend to provide diversification benefits when inflation is under control, but the recent inflationary period has reminded us that bonds do not always provide diversification, especially when inflation is threatening.
This makes the strong case for duration management, which can be thought of as management tactics requiring a traditional bond player to shift between midfield and defence depending on the prevailing conditions.
