In many parts of the economy, consumers assessing the performance of service providers are shrinking their time frames for tolerance of ‘under-delivery’. That’s certainly the case for investment managers where a plethora of ‘information’ is available in real time. But investment markets are inherently noisy. Fund managers need to help clients distinguish the signal from the noise and provide a realistic assessment of the progress they are making towards their goals.
Most fund managers prefer to focus on the management of the capital. They like to get on delivering returns believing that the numbers will speak for themselves. According to this view the numbers – judged relative to capital market benchmarks or a group of peers - demonstrate that good progress is being made. They expect that additional allocations of capital inevitably follow good returns.
While a single-minded focus on returns makes intuitive sense, there is a danger that the investment problem ends up being characterised as a series of sprint races. Naïve interpretation of investment returns can lead to unnecessary manager churn which reduces the prospect of good long-term client outcomes.
Focus on the long term
Most investment problems are more akin to marathons. Achieving a personal best in a marathon requires knowing the location of the finishing line and having the self-assurance to stick to a well-developed plan. This is particularly evident for goals-based investment approaches which are centred on an understanding of client goals and are specifically managed to provide confidence in goal attainment.
While popular thinking may currently ascribe three things an investment manager needs to do to deliver value to clients –
• gain client trust to earn the right to become a steward of their capital;
• manage the capital appropriately; and
• instil clients with confidence that they are on track to achieve their financial goals –
I believe that expertise in ‘journey management’ will become a defining characteristic of a successful investment manager.
A clear and mutually agreed understanding of client goals is a basic requirement. It is also important for investment managers to have a well-articulated view, established in advance and re-affirmed on a regular basis, of the range of possible shorter-term outcomes in a variety of realistic scenarios. Mutual trust between manager and client is important for this to work effectively.
The importance of goals
Unfortunately, there is no magic formula for assessing the progress of an investment strategy. There are a couple of reasons for this.
- There are many different types of promise that an investment manager may make to their clients. That’s why clarity of purpose is so important.
- For many investment approaches, success can only be sensibly measured over an uncomfortably lengthy time horizon. Investment strategies destined to out-perform over the long-term may look decidedly unimpressive over the medium-term due to challenging conditions.
The absence of agreement on goals can create considerable mistrust. Consider the ongoing debate generated in response to the Productivity Commission’s report on the Australian superannuation system. Every participant seems to prioritise a measure of success – realised returns, peer ranking, returns relative to benchmark, or risk-adjusted returns – suited on their own view of the purposes and goals for the system.
While in no way looking to deflect from criticism of unnecessarily high fees or poor investment governance, I would argue that it is hard to conduct a productive discussion on system performance if there is no agreement on the goals of super funds. The sense of confidence seemingly built on its delivery of high returns in one investment regime may well prove to be fleeting.
The challenges of journey engagement
The final strategy to consider is managing duration. Let me draw out some of the challenges of journey management through three examples:
First, let’s consider a traditional institutional mandate – to manage a well-diversified portfolio that delivers a return premium to the global equity benchmark. The asset owner takes responsibility for the allocation of capital and sets the financial goal for the strategy. While no one enjoys under-performance, clients usually express greater confidence if their managers articulate in advance the financial condition likely to lead to weak outcomes over the short-term.
So, the fund manager will provide an estimate of the range of outcomes around the benchmark over various horizons. They may also describe future investment conditions that may disadvantage their strategy and estimate the likely extent of any relative return shortfall. If their investment approach leads to consistent structural differences in their portfolio relative to the benchmark – e.g. a bias toward stocks with lower price-to-earnings ratios – then they can use independent metrics to help establish an acceptable size of shortfall should those conditions emerge.
A second example is a more contemporary mandate – to manage a concentrated equity portfolio likely to compound returns at eight to 10 per cent per annum in the long run. The difference here is the manager is taking responsibility for the total return of the strategy over the long-run and there is no easily identifiable short-term metric to assess performance.
In this case the manager must provide additional information to help maintain client confidence in challenging market conditions. A manager whose strategy focusses on companies with the capacity to steadily grow earnings for an extended period might choose to provide details on the progression of earnings in their portfolio of companies. This fundamental data series, much less noisy than the price of the portfolio, helps portray a sense of progress consistent with the long-term goals.
Finally, think about a retiree looking for a steady inflation-linked cash flow to fund their essential spending needs in retirement over the forthcoming 25 years. This is quite representative of a goal-based problem. Here the manager takes responsibility for the capital allocation and the investment strategy.
The challenge is to explain, in language that is easy for the retiree to understand, that their capital remains well-positioned to provide the promised cash flow. The manager may choose to focus on the sustainable sources of income delivered by select investments. They may evidence that some capital has been hedged against inflation and protected against weak markets. And performance of the strategy may be best explained indirectly, through its impact on the retiree’s future cash flows.
Investment managers have always managed client capital. They also have to help manage client experience. Journey management is intrinsic to a goal-based relationship. The investment management industry today is a long way from defining a best practice in journey management. But doing so presents a great opportunity for managers to cement long-term relationships with their clients.
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