Tuesday, August 21, 2018

Dynamic portfolio management and tools for building risk-adaptive portfolios

By James Perry, guest columnist

In the current environment of low yields, pricey equity markets and lower expectations for portfolio returns, institutional investors may find it challenging to meet their return objectives over the next several years. The traditional approach to institutional investing begins with setting a long-term strategic asset allocation, hiring managers and periodically rebalancing back any portfolio drift to the SAA weights. This approach could be described as a "beta-driven" approach as the bulk of the risk of these portfolios is derived from the beta of the portfolio. By contrast, "risk-focused" portfolios seek to find the best reward per unit of risk from both pure beta exposures as well as active managers and strategies and hence require reallocation dynamically to the best opportunity.

Many investment programs utilize a beta-driven portfolio approach with a focus on tracking error, mean-variance optimization, benchmarks and cost minimization. Reputational risk from running a portfolio with this type of structure is limited as when markets go up, the plan participates well and when markets go down, losses can be attributed to these shifts. Over time the upward bias of the market provides these investment programs with a combination of risk premiums over cash which provide the basis for the growth of their investments.

When volatility begins spiking and bear markets occur, however, a risk-focused portfolio not only helps protect capital but also enables the dynamic investor to seize opportunities. Having a diversified, cash flow focused portfolio that is less impacted by market volatility can provide an investor with the confidence and portfolio liquidity necessary to take advantage of market dislocations and more attractive long-term investment opportunities when they occur.

Dynamic Portfolio Management
Despite the sustained bull run in equities, many pension funds are still underfunded and require a high future rate of return on their assets. Long bull markets make it easier for pension plans and other institutional investors to meet their immediate target return objectives, but the higher priced assets also lead to lower expected returns in the future.

Investment programs with a greater focus on market risk and valuations that dynamically adjust their portfolios to adapt to the market environment will likely fair better in the next market downturn. This process of varying risk exposures to adapt to the market environment is a discipline that is sometimes referred to as Dynamic Portfolio Management. With a greater focus on capital protection and opportunistic investing, DPM can offer tools to enhance the probability of realizing more attractive returns over time and increasing the possibility of achieving investment return objectives.

DPM empowers CIOs and their teams with a set of tools that may be used to complement their existing portfolio structure and enhance their risk adjusted performance. Despite the many benefits of DPM, it does add layers of complexity to a portfolio. 

This creates the need for enhanced portfolio transparency, analysis, monitoring and reporting. This process can be further enhanced with the right set of strategic partners to help drive the dynamic aspects of a portfolio’s asset allocation and to create market intelligence and insight from a portfolio’s data, offering the potential of allowing plans to meet their long-term investment objectives in the lower return environment that we may all soon be facing. Visit Maples Fund Services’ website for more information on the principles of DPM and the benefits it can afford allocators. 

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of Maples Fund Services or TEXPERS. 

 About the Author
James Perry is head of Institutional Investor Solutions at Maples Fund Services where he is responsible for shaping the firm’s offerings and enhancing its service delivery to institutional investors. He brings more than 20 years of investment management experience including senior investment roles overseeing portfolios of public assets in California and Texas. Perry is a recognized thought leader in the investment industry, as evidenced through a number of awards, including being named as one of the Top 30 Pension Fund Chief Investment Officers (Trusted Insight, 2016) and receiving the Investor Intelligence Award for Innovation (Institutional Investor, 2014). 

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