One of the most positive developments in institutional investing over the past two
decades has been the focus on risk budgeting. This trend has resulted in, amongst other
things, an increasingly forensic focus on mandate requirements to ensure, for example,
minimum or zero overlap between different client portfolios. This has had the advantage
of bringing ever greater clarity to both the client expected outcome and understanding of
the instruction to the service supplier.
A result of this development has been that interactions between both parties have
become ever more focused on a tighter range of mandate specific issues. For the
service provider, the objective has been narrowed down with a view to focusing them on
ensuring that stated targets should be met or better still exceeded. If this has been
achieved, the assumption is that everyone will be happy.
Not quite. There will be circumstances where market beta fails to deliver. Then we
arrive at a situation where there is a disconnect between how both client and supplier
feels; the former is left disappointed as the asset class performance has fallen short, but
the latter is happy because they have delivered on the objectives set for them.
One industry response to this disconnect has involved the emergence of absolute return
strategies, with one desired outcome being the lessening of dependence on market
beta, which as we all know will sometimes disappoint us. But this innovation, whilst
welcome, has produced disappointments of its own so therefore cannot be said to be a
solution for everyone.
A useful alternative approach could involve more of a problem-solving orientation of the
macro or strategy functions that all service providers in our industry possess. These
teams and functions contain significant intellectual capital that, in theory at least, we
would expect to be aligned with the long-term requirements of clients. However, what we
observe is a considerable proportion of this resource getting tied up in backward-looking
macro commentary and in the production of geo-political and economic output for
marketing departments. We note and applaud indications that service suppliers are
beginning to allocate increased resource into modelling potential future beta patterns
across asset classes that could be usefully superimposed on customers strategic
allocations for the benefit of clients.
But there can be no off-the-shelf remedy that comes close to the benefits of a truly close
service supplier, client relationship. Achieving this requires allocating organisational
resource to the investigation of how clients are really feeling about the fundamental
usefulness of their service supplier relationship, especially when it is most needed.
Oftentimes organisations worry about the potential uncomfortable truths that such
investigations may uncover, but there is consolation to be found in the academic
research pointing to the sustainable competitive advantage such knowledge confers on
those who commit to seeking it out.