According to the publication, the building blocks of equity portfolios have evolved beyond market cap-weighted passive equity and active management. Smart beta is now a third pillar that targets systematic factors and nonmarket cap stock weighting or thematic investment opportunities in order to capture particular premiums, typically at a very low cost.
“Developments in equity markets and the industry have added complexity and breadth, in terms of available products and portfolio construction tools,” said
Asset owners must be adept at manager selection, as well as portfolio construction, in order to identify skilled active managers from a universe of many thousands of competing products. A core principle is to make sure active managers are best in class and providing differentiated strategies that cannot be replicated more cheaply elsewhere using smart beta. Asset owners should introduce new channels for risk and reward, for instance, through the implementation of a long/short portfolio alongside the long-only portfolio, or through more activist strategies.
“We are open-minded about where to look, but often the best specialist equity managers are found in boutiques established to provide greater focus,” said MacLachlan. “In some cases, they may be managing money for high-net-worth individuals or running hedge funds. Often, the mindset or skill set of these investors is different. For example, high-net-worth managers tend to think in terms of absolute return rather than relative to market indices.”
Investors targeting high levels of expected excess returns through active management may want to consider amplifying niche strategies through highly concentrated (10 to 20 stock) mandates within an equity portfolio, comprised only of the active manager’s best ideas. Studies have shown that portfolio managers often add value in their high-conviction stock picks but destroy value with the unintended underweight positions in the portfolio. Having more concentrated portfolios with assets focused in the manager’s highest-conviction ideas should offset unintended underweight positions and lead to better outcomes.
“In a highly competitive world, we believe asset owners should simplify their strategy (for example, go passive), or raise their game in order to deal with this complexity and benefit from it,” said MacLachlan. “While there are greater expected rewards from the latter approach, it requires more internal governance and portfolio construction skill from the asset owner, and therefore may not be suitable for everyone. Asset owners should determine what level of complexity is appropriate, given their requirements and their governance levels.”
The new publication provides practical insights into equity portfolio construction, manager selection and manager monitoring. It includes articles on:
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