“I want freedom for the full expression of my personality”
When saying these words, Gandhi probably wasn’t thinking of asset managers. Nonetheless, this phrase illustrates one of the factors of success of flexible portfolio management in recent years: by giving the manager a greater degree of freedom, investors can reckon with a better reflection of their convictions in a portfolio’s positioning.
The Great Financial Crisis that began in 2007 has also shone a light on the value of an approach to portfolio management which is capable of adjusting itself very dynamically to the twists and turns in the trends within a market cycle. Rather than manage risk portfolios using “tracking error” in combination with fixed baseline allocations, we are talking about positioning a portfolio in the most attractive assets, even if that means drastically reducing the exposure to other categories of assets.
This increased freedom for the portfolio manager goes hand-in-hand with greater uncertainty for investors. If the portfolio manager has the liberty to allocate to his preferred assets and fundamentally change the structure of the portfolio, how can we avoid an excessive concentration of risk in a single asset or type of position? Excessive concentration may enable a manager to do very well one year and then very badly the next. What we gain in liberty of expression can be lost in our visibility of the risks to which we are exposed.
At THEAM, our response to these challenges is twofold: diversification and model-driven portfolio management. Diversification is standard practice but it is worth remembering that in a globally diversified investment universe, expanding through diversification-providing assets such as listed real-estate or so-called hidden assets, such as implied volatility, a portfolio manager has a better chance of capturing market opportunities and mitigating the impact of a negative surprise for a given asset. As for the quantitative models, they provide increased visibility of the flexible portfolio management process. To take a concrete example, the “Iso volatility” strategy, implemented notably in our dynamically allocated funds, reduces or increases the risk exposure for each asset in the universe depending on “the climatic conditions” in financial markets. The higher the volatility, and thereby the risk associated with an asset, the more exposure is reduced.
Portfolio management in terms of risk is therefore placed at the very heart of the investment process. This discipline can help us to reconcile flexibility and peace of mind. As a result we can reply to Gandhi’s quote with another, from Virginia Woolf: