By Matthew Bale, Chief Strategy Officer, RiskFirst
The asset management industry is undoubtedly complex. With an ecosystem comprising multiple stakeholders – portfolio managers, consultants and asset owners – it is unsurprising that discrepancies, miscommunication and a loss of information can occur between parties.
Typically, the process and flow of information starts with the asset owners’ objectives. Working with a consultant, these objectives are distilled into a strategic asset allocation. This strategic asset allocation is then implemented with a set of asset managers, who are benchmarked against a standard reference index. The money is ultimately transferred to the portfolio manager, who then builds the portfolio itself. Inversely, the portfolio manager reports back on its performance to the asset owner via the performance and client reporting teams, and the consultant.
This multi-stage approach involving minimal direct correspondence between portfolio managers and asset owners is somewhat akin to the childhood game “Chinese whispers” – in which a message is whispered to someone, and transferred progressively along a line to several others, with inaccuracies inevitably accumulating along the way. This can result in two key shortcomings: portfolio managers managing a portfolio that may not best meet the objectives of the asset owner; and asset owners not being able to accurately assess the asset manager’s performance. Both can create significant issues in practice.
There may be instances, for example, where a pension plan (i.e. the asset owner) is paying out pension benefits over decades – 10, 20, 50, even 100 years into the future – meaning its obligations are very long term. That asset owner, unlike many other investors, has the significant benefit of being able to take illiquidity risk – a risk that investors would expect to be rewarded over the long-term. Yet, the portfolio that is implemented could instead be heavily invested in liquid assets, meaning the asset owner is potentially paying a liquidity premium for something they don’t actually need. This misalignment derives from the fact that the portfolio manager is so distant from the asset owner that the objectives have become diluted by the various parties within the chain.
Equally, portfolio managers could benefit from being closer to their clients – the asset owner – when communicating their performance. There are various factors that drive the performance of a portfolio and the performance of the benchmark, and trying to communicate that effectively to clients can be challenging.
Differing needs, differing systems?
Further adding to the issue is the fact that portfolio managers, consultants and asset owners each have such different outlooks and time horizons. For instance, asset owners are paying out pension benefits over decades yet portfolio managers are often looking at daily or intra-day views of their portfolios. In terms of priorities, asset owners want to ensure they can meet liabilities and pay beneficiaries; consultants want to achieve the right risk-return dynamics for their clients; while portfolio managers want to meet or exceed their performance benchmark.
With each stakeholder focusing on different things, different technology platforms have been evolved to cater to specific needs, meaning that separate, siloed systems are being used in each of the different verticals.
Yet, while it may appear that separate systems are needed, technology is evolving to allow fast, sophisticated common platforms to be created with the flexibility to be customised to meet the objectives of all parties. Both portfolio managers and asset owners can log in to the same web-based platform and see the same information – with varying detail according to individual requirements.
Certainly, asset owners will not need the same degree of detail and quantitative analysis as a portfolio manager. But importantly, that doesn’t mean they need to use a different model; they need a different lens into the same model. It is therefore about how the information is delivered to the asset owner – with portfolio managers able to ensure it is consistent with their numbers, but presented in a way that helps asset owners understand the portfolio and portfolio manager performance, and how it is ultimately affecting their ability to achieve their investment objectives.
Through such platforms, portfolio managers and asset owners can work more closely together, driving: more effective, direct communication between stakeholders; greater alignment of objectives; helping asset managers more effectively explain performance attribution analysis to their clients; and thereby helping asset owners to better understand what is driving portfolio performance.
Despite differing priorities and areas of focus, the desire to understand and validate decisions within the context of the investment process chimes with all. With that principle in mind, the entire investment journey can be underpinned by one, unified platform, facilitating greater integration and harmonisation along the asset management chain, and ensuring asset owner objectives remain at the forefront of investment decisions.
Overall, it is important to remember that asset owners are the linchpin of the investment industry. Asset owners are the reason that the investment management industry exists, yet we often fail to pay enough attention to them and their core objectives. In my mind, the industry works at its best and can only be truly effective when the asset owner is at the centre of asset managers’ strategies and procedures.