Wealth Strategies
Getting Into The Details Of Investment – In Conversation With Partners Capital
This publication talks to an international investment house about the future of the "60/40" equity-bond portfolio split, the role of alternative assets, how to steer a course through geopolitical turbulence, and more.
Back in August, this news service
spoke to Partners Capital, an outsourced chief
investment office overseeing $55 billion of assets, about the
importance of after-tax returns. A very important consideration
today when governments could hit investors on both sides of the
Atlantic with higher taxes.
Away from the specific tax concern, however, there is much else
to understand about how approaches to asset allocation and risk
are evolving. We spoke to Euan Finlay (pictured), head of EMEA at
the firm. This is a business that prides itself in its "endowment
model" of investing – holding illquid and liquid assets to suit
the time horizons of clients, often in ways that involve holding
private market investments and other "alternatives."
WealthBriefing: What is your current overall
approach to risk and risk assets in terms of what level of risk
exposure you are prepared to take for the next six to 12 months?
Please give reasons for the stance that you take.
Finlay: Our belief is that aiming to generate long-term
outperformance by varying risk level based on macroeconomic views
is very challenging. Few investors get this right. Accordingly,
our philosophy is to keep risk constant requiring rigorous
re-balancing back to target risk metrics throughout the cycle. We
believe that this discipline can consistently add outperformance
over decades for our investors. Therefore, for the next
six to 12 months, our overall portfolio risk level will
remain in line with long-term targets, as per our investment
philosophy.
WB: In what ways have your risk approaches
changed over the past one/two years, and why?
Finlay: What changes year-to-year is the asset classes
in which our portfolios invest, albeit, calibrated at the overall
portfolio level to maintain constant overall risk. In the last
two years, we have allocated more to credit, both publicly traded
credit (particularly structured credit) and private debt (upper
middle market direct lending when the opportunity was
particularly attractive, but as the weight of capital has
compressed spreads for larger loans, we have migrated to lower
middle market, capital solutions and sectors where the supply of
and demand for capital are more in our favour to the benefit of
spreads and credit documentation).
We have also increased allocations to absolute return strategies
which we believe benefit from both a higher base rate and
potentially a more volatile environment to their benefit.
WB: What is your approach to diversification? Is
the old 60/40 equity/bond allocation split now dead or is there
still traction in it, given the recent rises in the risk-free
rate as central banks have raised rates?
Finlay: The 60/40 equity bond portfolio relies on the
correlation benefit between equities and government bonds. With
the re-emergence of inflation, which we believe will be biased
upwards in the years to come, that correlation is less reliable.
Accordingly, we diversify across many more asset classes
including absolute return, property, highly collateralised
lending and truly uncorrelated strategies such as litigation
funding and royalties. Whilst government bonds clearly play a
role in multi-asset class portfolios, we would not rely on them
to the extent of the “40.”
WB: How large a part of your approach to
diversification and risk is taken up by private markets, hedge
funds, commodities and real estate? How do you execute these
ideas – do you go for funds, listed
alternatives, exchange-traded funds, others? What are the costs
and risks of such approaches? How do you try to ensure portfolios
aren't overly complex?
Finlay: Very significant. “Alternatives” broadly
defined can be 60 to 70 per cent of our portfolios (although we
do not invest in commodities). We are believers in private equity
and expect that it will continue to outperform public markets due
to a combination of our belief that private ownership is a better
governance model and the operational value that private market
managers can bring to portfolio companies.
We expect outperformance will be in the middle market, those
managers that have operational improvement capabilities and, in
those portfolios, where investors can co-invest alongside
managers to reduce total fees. We invest in third-party managers
and co-invest alongside them. This is facilitated by decades of
investing in these asset classes resulting in high quality
sourcing plus improved decision-making,
very substantial teams situated globally to cover local
markets, technical expertise in assessing managers and
transactions, dedicated co-investment teams to source and move
quickly thereafter, and the requisite scale to drive improved
terms.
We also invest in hedge funds, predominately absolute return
(those strategies with minimal directional correlation to
traditional asset classes). Judiciously constructed, these
portfolios can generate 3 to 5 per cent premium over the cash
rate over the long term with minimal reliance on equities and
bonds. This introduces substantial uncorrelated return into
portfolios to the benefit of clients, in a world where achieving
true diversification is increasingly challenging.
WB: Getting asset allocation right also requires
a lot of data, and that means having the technology to enable all
this to be analysed correctly and quickly. Can you discuss a bit
about how you do this?
Finlay: I agree. The “table stakes” requires
depth of team (data teams, tech team and investment teams) and
willingness to invest in data processing capability. But we
endeavour to ensure that we are sourcing data and information
from differentiated sources. For example, we are invested in many
of whom we believe to be the premier asset managers in their
sector/niche. The information that is shared through our regular
interactions with those managers (plus the other 2,500 manager
interactions that we have each year) provides a highly
differentiated source of real-time data/information that is
difficult to replicate. Finally, no matter how high quality the
data, investment performance still requires judgement executed by
experienced and high-quality professionals.
WB: What's your approach to where "direct
investing" (not using a pooled fund structure) fits into a
client's portfolio, if at all? Assuming a client might be an HNW
or UHNW individual, do you tilt towards such ideas in particular
ways?
Finlay: Our direct investments are typically
co-investments in private equity, private debt and real estate
alongside our selected managers with no (or highly discounted)
fees. These play a very significant role in our portfolios given
the return potential (i.e. benefitting from significant fee
savings in addition to the return of the underlying investments).
However, with the exceptions of our co-investment capability and passive exposures in index tracking funds which are acquired directly, our portfolios are typically invested through third-party asset managers.
We do not have in-house asset management which acquires stocks,
corporate bonds, real estate etc directly; this is partly given
our ethos of eradicating the inherent conflict of interest that
can create and a belief that in the competition for talent, those
most likely to generate outperformance through security selection
are attracted to owner-operator firms with significant alignment
of interest. Accordingly, to access those individuals, we invest
in the funds that they manage.
WB: How concerned should we be that alternative
investments are off the table for anyone outside the HNW bracket,
often because regulators won't allow people in the retail/mass
affluent space to engage in them? What signs of change do you
see? For example, do you think that "evergreen" structures for
private equity can help unlock this problem?
Finlay: Given our investment philosophy, it
would follow that we believe that the returns of portfolios would
be enhanced through allocation to alternatives. However, these
asset classes are complicated, often have high fees and can be
illiquid. We believe that construction of portfolios within these
asset classes requires large and experienced teams which are able
to source attractive opportunities and the ability to perform the
requisite due diligence. In short, certainly an opportunity to
enhance returns but “do not try this at home.”