Pioneers of objective-based investing: how the idea came to life
Simon Doyle and Simon Stevenson launched the Schroder Real Return CPI+5% Fund 10 years ago this month — one of the first objective based multi-asset funds in Australia. In this article they discuss launching amid the GFC, and how this style of investing comes into its own during times of volatility.
You were designing the investment strategy as the GFC was about to hit. Can you talk through how the world looked at that point in time? What was the most important lesson from the GFC?
Simon Doyle: You’ve got to go back beyond 10 years, to 2005 or 2006. The investment landscape was single-manager balanced funds that were 70:30, 60:40 equity/bond strategies, and the problem we had was that you couldn’t de-risk your portfolios. If markets fell sharply, then these types of portfolios would also fall quite significantly because they were structurally embedded with equity risk.
Your ability to really manage your overall risk exposure was limited by the rigid constraints imposed in these balanced funds. This inability to adjust asset allocation was the underlining problem that investors were facing. We felt that it was probably a good time to actually do something about it.
How did the idea come together to address the underlying problem?
It was because of this dependence on fixed strategic asset allocations and narrow ranges: this belief that you needed equities full time to generate returns; that the trade-off between return and risk was positively sloped —assets that had more inherent volatility got you higher returns.
It’s quite simple— investors want a return, then there’s a timeframe, and then there’s a methodology – your asset allocation. These are the three sides of a triangle. A balanced fund is based around this idea that if you hold a 70:30 portfolio in three to five years, you’ll get 'X' return. Our contention is the stated return is what investors want, and there is a timeframe they have to invest. The bit that’s the disconnect is the methodology.
Simon Stevenson: Basically, you can’t fix all three sides of the triangle. You can set two of the parameters but then the third one falls out. For example, you could fix your return target and the time frame but you will need to adjust your asset allocation to achieve this. Alternatively you could fix your asset allocation and return target, like most balanced funds, but then the timeframe needed to achieve this becomes variable.
With the pre-existing model, to get your return target with a fixed asset allocation, your timeframe might have to be greater than 50 years. As the timeframe extends you get more confident. But to be 90 per cent confident, based on historic data, you require something like 85 years.
Simon Doyle: So either your timeframe needs to extend, or you need to reduce return expectations. But investors don’t care about methodology or asset allocation; the return is what they want. Our task was to solve that but by doing something different with the methodology. And the solution was, effectively, if asset allocation is what ultimately drives returns and drives risk then we need an approach to asset allocation that is forward looking and relevant over the timeframe that we’re investing. In 2007 we did a fair amount of pre-work, with a lot of discussions with clients about the issues and how we were thinking about it.
Simon Stevenson: When we designed this, there was a concept — but how do you actually invest that way? What mix of asset classes do I need to get my objective over the next three to five years? It’s a very different mindset.
As you were engineering a new approach to investing, around solving a particular problem, how did your initial meetings go with investors?
Simon Doyle: Initially all the presentations were about, the ‘why’, as opposed to the ‘how’. I recall us standing at the whiteboard trying to work it out, because if we’re going to commit to a return target over a timeframe, we need some idea of what assets are likely to deliver for us over that timeframe. What will equities return? What will different equity markets return? What will credit return? What will bonds return? What will currencies return? We had to solve that problem, and I think until we’d solved that and had a process in place, we really couldn’t go to clients because we didn’t have a concept.
Simon Stevenson: In 2008, people were getting absolutely smashed. And then we launched on the first of October, not long after Lehmans went bankrupt, and markets got absolutely belted again. So there was a lot of focus within funds, with advisors, and superannuation funds on ‘what’s the problem, why are we down’? It’s because we own equities and we own credit and that’s where a lot of the problems are. What the GFC actually did was refocus people’s minds on the fact that asset allocation mattered, not stock selection or selecting managers to manage those stocks; what assets you owned and how they are put together is the most important decision you can make in a portfolio.
How did you get the first investors on board?
Simon Stevenson: In my experience, in this industry, you need a three-year track record before people start giving you significant amounts of money. It’s amazing — it’s a magic number in this industry.
Simon Doyle: Suddenly we got to 2010 and we got our first two institutional clients. We got there faster because I think it was a compelling argument. The other thing that helped us was the performance of our balanced fund, because going into the GFC we’d cut our equity exposure to the minimums and we’d raised cash to the maximums. We were as well positioned in a balanced fund as you could be going into that period, and so our balanced fund shot to the top of the league tables by a long way. I think if we hadn’t done so well, it would have been more difficult. The timing probably helped, but the timing was driven by us identifying the need.
By design, you’re not about shooting out the lights on returns. Are clients comfortable with that objective?
Simon Doyle: We never set out to promote ourselves as the highest returning fund in the environment. On any given day, just by definition, there has to be something doing better than the fund. If you look at a bear market it’s probably bonds, or in the bull market it’ll be equities. The continual communication with clients about what we’re trying to do, and how we’re going about it, will continue to be incredibly important because you don’t want people to lose sight of why we invested in this strategy in the first place, which was to solve a particular problem. But we expect to do well, and our clients expect us to do well, in more difficult environments. And I think you can see that again this year.
What’s different about how you run your team?
Simon Doyle: I think it’s wrong to assume that more people translate through to better outcomes. What we did was shift away from having a balanced-type portfolio approach, where you have an asset allocation committee and a strategist and the heads of the equity, fixed income, property, and global equity all sit around the table. There’s a bit of an auction, and that’s how you debate and end up with your views. I think that’s completely the wrong way to do it — particularly when you’re managing a strategy where it’s the totality of how you put it together that matters, and you have to be accountable. When it comes to implementing, then of course we need people to do that. And that’s when we draw on the broader resource. I believe it’s important to have your beliefs, and ensuring you’ve got a process that aligns to those beliefs. So how do you process information, how do you think about it? The views you have should fall out of your process. Conviction really arrives from the quality of the thought process that goes behind it; it’s not a function of the loudest voice. For our clients, the one thing that has been really important to us is we’ve been consistent from day one. There’s been clarity around the problem we’re trying to solve for them. They know, by and large, what we will be doing.
People know that when markets are expensive we’ll be reducing risk. They expect that when volatility is low we’ll probably be more defensive. That’s what our style process, our philosophy, has told them.
Given the importance of communicating strategy, and implementing that strategy, how do you insulate against key man risk in the team?
Simon Doyle: The first is you need to build a succession plan so if a bus hits me I know Simon [Stevenson] can pick up and run with it. The second thing is to institutionalise the thinking. What we’ve tried to do is institutionalise as much of the philosophy and process, such as how all the models are run, the optimisers are run, the strategy pack is produced, and established research groups across the team. All the inputs into the process are done outside us, and happen as a matter of course.
Part of the success has been that we have had stability, particularly Simon and I, as a part of this. And we’re working on it together — it’s not like it’s been my strategy, it’s ours and we try to share the development of the process and the engagement with the clients. The key is to make sure we’ve got the right people culturally, philosophically, behaviourally, and intellectually. It’s not about too many people — it’s about the right people.
Simon Stevenson: The thing with Simon [Doyle] is, if he trusts you he trusts you, and you can do a lot. So it’s part of the advantage here. It’s challenging, it’s intellectually stimulating, so you have an organisation that provides something that is really interesting to do, each day.
For any further questions, please contact us.
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