Setting and Maintaining Client Expectations
What’s the relationship with your client?
No easy answer, educate them and use skills of persuasion. Firms that are successful have a clear path and are able to effectively communicate that to clients: consistency between the narrative and the numbers must always be there.
Go into a meeting, you always see a series of statistics that confirm the philosophy and process.
In this room, there is probably a lot of survivorship bias.
Entities say they are not going to allocate to a fund after it’s achieved short-term positive relative performance. However, 2.5 year relative returns are the most correlated to fund allocation decisions.
Concentrated Factor investor will have high tracking error, however, we do what we say we do. Clients are educated about what to expect and we stay the course.
Are sales/marketing telling a story consistent with the portfolio management’s reality? Are the alpha target, risk parameters and marketing positioning aligned?
We have a few RIAs in the room. How do you think about allocating between managers? How do you think about performance relative to your expectations of those managers?
We are suspicious of abnormally good or bad performance.
We believe that things work over time because things don’t work all the time. When looking for new managers we ask: what works over time that isn’t working right now?
When you build the business, you get the clients you deserve. The most important thing to market is your process, style and core philosophy. You can only control the consistency of approach, not neccesarily the consistency of the outcome.
There’s an old Buffett’s adage that it is okay to sell someone a ticket to a rock concert and okay to sell someone a ticket to the opera. You don’t want to sell people tickets to the rock concert if they really want to see the opera.
Portfolio Risk Management
What’s the objective of a risk manager?
I try and help portfolios achieve the highest possible risk-adjusted returns. There’s a need to set an appropriate risk budget given the objective of the client base or fund mandate.
It is important to know what you’re trying to achieve. Are you trying to beat a peer group or absolute level of alpha? A risk level that is too low is just as poor as risks that are too high. Alignment is crucial.
In a low volatility environment there is an increased use of stress testing and scenario analysis. Consider, for example, how you would have performed in the taper tantrum of 2013.
What’s the inherent risk of the portfolio? Are you comfortable with that?
Who makes judgement on whether there about to be another taper tantrum?
Determining which numbers are meaningful from risk model outputs is one of the roles of the risk manager. The crisis in 2008 emboldened the importance of risk management.
How do you think about your approach and aligning it with clients’ needs?
Too often the discussion is that my horse is faster than your horse, so bet on my horse. What’s the appropriate role given needs/circumstances of a client? You must consider what your clients have, what do they need, how severe is the pain if they don’t have what they need when they need it? You need a useful framework to identify role of asset allocation and selection within each asset.
If all your products are exposed to the same style factor, how do you mitigate that risk?
Concentrated style risk is a commercial risk, not a portfolio risk. As a business you can diversify the client type, geography and distribution in most channels, but still fall prey to the style risk. You must employ rigid risk constraints. One way to do this is to reduce degrees of freedom for portfolio managers. You can move from the belief in the genius of an individual that “seems like a good idea and I’ll buy a few” to a more structured process. You need to objectively define quality or other styles.
The Active Management industry will resist passive encroachment by incorporating quant with discretionary. Figure out what humans and machines are good at and let humans do what they are good at doing and use machine for they are good at doing.
Target date funds attempt to better understand clients’ needs/preferences and be sensitive to clients. It is just a technology issue. Investment firms will benefit from building the technology to better align with clients’ wants/needs.
How do you think about Risk Management as a Portfolio Manager?
Models of risk using today’s views of volatility greatly underestimate risk. Those same models in 2009 would show much more “risk” for the same portfolio. It’s important, then, to have rules that are informed by experience across market cycles. It’s also important to consider how the current portfolio would look in different models.
However, the problem is that underlying companies are changing. There’s no way to know how those companies would behave in an alternative scenario. Like the old saying: there’s no such thing as one river, but rather just different particles running through it.
Is the portfolio robust through a given period? From a performance perspective, clients forgive upside tracking error, but dislike downside tracking error, so relative performance is important. This comes back to client communication. You must be clear when you are more or less likely to perform well in a certain market environment.
