Market Views: Multi-Asset
Multi-asset investing in tough times: the human factors to consider
Last year was tough for multi-asset managers all over the world. I believe 2019 will also be challenging, due to a slowdown in global growth and increased volatility, the latter mainly as a result of political factors. An asset manager that can help asset owners navigate this environment is imperative. However, at these times, I believe that the key to continued success is less about the investment process and more about the way in which a team is structured, its culture and its accountability.
True multi-asset investing is a relatively young investment approach and as such, few teams will have been through the turmoil of 2007 and 2008 and may be unprepared for the challenges ahead. At Schroders, we have managed multi-asset mandates from 2006, and in this paper, I share what I believe to be the key to a successful team through more difficult times.
People are the key
Research shows that there is a link between good culture and good results1. In my view, it all starts with a recognition that investment is about people. The “market” is an agglomeration of millions of souls seeking to generate wealth. Our investment teams are microcosms of the broader market environment and the question of how you create a high performing investment culture is inextricably linked with the individuals involved and how they interact with each other. Indeed the importance of human behaviour to market performance is the reason why investment philosophies are necessary; if investing were an exact science, there would be no need for a philosophy, we could just calculate the exact intrinsic value of any cash flow and that would determine the correct price of the asset2.
Coping with mistakes
An investment philosophy is a set of beliefs that underlie the investment process. The investment process is the strategy for implementing the philosophy and is the means to an end. Many emphasise (increasingly scarce) informational advantages but research into institutional investors shows ‘culture is the unique ingredient in the recipe for competitive advantage. While investment strategy can be mimicked by competitors, culture is difficult to recreate’3. I believe that the most important part of culture within an asset manager is how to deal with behavioural issues and specifically how to cope with mistakes. The reality of being a portfolio manager is, even if you are successful, that you are probably making wrong decisions 40% of the time. How can you create investment processes that help you to cope with that chronic failure and ensure that investment performance is maintained? How can you proactively identify and minimise mistakes that stem from cognitive bias? How can you ensure that you fail better than others?
I suggest that there are five key elements to structuring a successful multi-asset team:
Firstly, it is human nature to want to focus on one’s successes and explain away one’s failures but this natural human tendency is corrosive to investment performance and compounded by the greater the number of people involved in a decision. A key problem to overcome is the idea of ‘groupthink’ whereby the committee makes a decision with many of its members agreeing with it but not really having conviction in the idea. This is a consequence of herding behaviour. Sometimes it is easier to go with the crowd, as the peer comparison risk is lower. The impact of one’s decisions needs to be measured and ideally, an individual needs to be held accountable for any single decision with a clear link to financial incentives. This ensures earlier recognition of mistakes.
2. Skin in the game
Traditionally, multi-asset investment committees in large investment management companies were comprised of the heads of those asset classes who would manage individual portfolios. In order to help make asset allocation decisions they would be asked to provide the case for their particular asset class, together with short-term return forecasts. This process poses problems from a behavioural point of view. These types of committee members were primarily responsible for stock-picking and promoting their individual asset classes. Therefore, espousing the relative merits of different asset classes was not necessarily their day job or what they were rewarded for. As a result, they had no “skin in the game” for making such calls in the sense that they would not be measured and rewarded for these kinds of decisions. They are rewarded for generating good performance within their respective asset classes and as a result, attracting more assets. Thus, there might be an upward bias on the forecast prospects for their asset class.
3. Size of the decision making team
Another vital consideration is that of the size of the committee. Too large and it becomes unwieldy, lacks coordination and accommodates passengers. In fact, there is a phenomenon known as the Ringelmann Effect4 (often illustrated by a tug of war situation where as additional members of a team are added, their marginal effectiveness decreases) which describes the tendency for individual members of a group to become increasingly less effective as the size of the group increases. Too small a team though, and it becomes undemocratic and over-concentrated. Some social scientists have suggested that five or six may be the optimal size of a team. There is a definite ‘Goldilocks’ effect when considering the appropriate size of an investment decision making team.
4. Creating healthy rivalry
Increasing the bench strength of an overall team is important. Competition for places is vital in order to keep team members on their toes and avoid complacency. It is important to give emerging talent the chance to show what they can do. They should be allowed to participate and be measured in the same way as full members of the investment committee. Incumbent members should be aware that they can be replaced if relative performance records over time suggest that it is optimal to do so. There should be a flat structure with little hierarchy so that open debate is encouraged and investment positions may be challenged.
5. Diversity of thought
Finally, to ensure that an investment is really viewed from every angle, I am a big believer in diversity of thought as it enables us to look at risk from every angle. Although this concept is now quite fashionable, some researchers suggest that too much diversity is undesirable as similar individuals are more likely to share values and thus work more effectively towards a common goal. I think there is some truth to this and diversity needs to be managed carefully. I sometimes compare bringing individuals together with opposing perspectives as a “controlled explosion”. It is important to have the confrontation but certain behaviours must not be tolerated: talking down to people, aggression, humiliation and not taking questions seriously. As leader of the team, it is important to recognise that individuals might be upset and to act as an emotional buffer so that individuals feel heard throughout the process. In short, badly-managed diversity can have very negative outcomes while well-managed diversity allows us to continue to grow and develop.
Lastly, the “grease” which allows all of these elements to work together is trust. This critical ingredient increases the resilience of the team to the pressures of accountability, rivalry and diversity in particular. There are no shortcuts, trust is built over years of working together and the unrelenting application of common standards of behaviour.
After more than 21 years as a multi-asset investor, I believe that it is increasingly important to proactively identify and minimise mistakes that stem from cognitive bias. At all times learning how to fail well and deal with mistakes is imperative to ongoing success. In tough times, I believe that this ability is the key to competitive advantage. I have highlighted five key elements that I believe are important for structuring a successful multi-asset team. An investment process that focuses on analytical advantages is clearly important but the culture, structure, trust and accountability of the team is what sets it apart from the competition.
1. Corporate Culture and Performance, John P Kotter and James L Heskett, The New York Free Press, 1992.↩
2. The Role of Investment Philosophy in Evaluating Investment Managers, Minihan, J, Journal of Investing, Summer 2006.↩
3. The Impact of Culture on Institutional Investors, R Urwin,, Willis Towers Watson, August 2015.↩
4. Journal of Experimental Social Psychology, Volume 10, Issue 4 July 1974.↩
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