LIMA MBEU: Expert Opinions: Edition October 2019 / January 2020

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Adapt or die

A new era has emerged within the global investment
management industry, suggests Lima Mbeu Investment
Managers CIO Ndina Rabali.

Introduction

It has become clear that, for us to understand today’s increasingly complex markets, we require much better analytical methods than the blunt instruments currently in use. Traditional methods of investing have struggled to cope with rising market complexity, and active managers have underperformed their benchmarks. The clamour for passive investing is increasing. In response, asset managers across the world have developed a set of new and innovative investment approaches. Methods such as quantamental investing, that blend investment insight with the discipline and transparency of a quantitative framework, have emerged. The rapid development of technology and data over the last ten years has aided the emergence of these new-age investment approaches.

Why should pension funds consider these new approaches to investing?

Many remain sceptical. The collapse of the hedge fund, Long Term Capital Management (LTCM) in the late 1990s, is often attributed to the use of an overly complicated investment approach. Many also blame the use of sophisticated investment strategies for exacerbating the global financial crisis of 2008. The key difference this time is that most practitioners have learnt that using complex mathematical algorithms to predict future prices is unwise! However, these techniques can be quite useful in enhancing judgement and the decisionmaking process when investing.

The primary reason for considering the use of these new methods is the market-sum rule! If some pension funds beat the market, earning higher returns than the market, then other pension funds will be beaten by the market, earning lower returns than the market. In other words, an investor that underperforms the benchmark is merely contributing to the outperformance of another investor. With the rapid development of new techniques to investing, investors that are slow in adapting to change run the risk of funding the improved returns of those that embrace it.

Are investors adapting?

When it comes to change, no one wants to be the innovator or the laggard because of the high risks and penalties involved. Two examples show that investors across the globe are embracing change. Although there are several examples, we highlight two of particular significance.

Firstly, in 2009, the Norwegian Government Pension Fund (over $1trn AUM) requested consultants to conduct an evaluation of the value that active management adds within the pension fund. The findings were quite revealing. Active management was a small but positive contributor to the performance of the fund over ten years. However, the returns may have been better if the pension fund was managed using a framework that combines bottom-up fundamental investing; with factor-based construction of its benchmarks. The consultants recommended a re-organisation of the pension fund to adapt to this new framework

– one that seeks to harness the power of ‘human and machine’ to deliver investment performance for their members.

Secondly, in 2017, BlackRock ($6,8 trn AUM) re-organised its active equity offering. The asset manager introduced quantitative techniques into the fundamental bottom-up investing team in an attempt to improve the performance of its funds. Mark Wiseman, the Head of Active Equity at BlackRock said at the time: “The old way of people sitting in a room picking stocks, thinking they are smarter than the next guy — that does not work anymore.” BlackRock, therefore, decided to combine their quantitative and fundamental investment teams into one cohesive unit. As Wiseman further put it: “The active equity industry needs to change. Asset managers who use the same techniques and tools from the past will limit their ability to generate alpha and deliver on client expectations.”

Rabali…quantamental approach

These two examples, of a large asset custodian and asset manager, demonstrate that we have moved beyond innovation. Globally, the investment management industry has already embraced the use of innovative, new-age investment processes.

Is there any logic behind the emergence of this new era?

Although we all hate change for the sake of change, there is a simple logic behind the rapid developments we see in the investment management industry. Information has been made easily accessible to everyone! The competitive advantage that asset managers have lies in their ability to access information and process it better than others. Advances in technology have decimated this advantage. Today, we all have access to the same news feeds, databases, and research reports on companies. The competitive advantage that analysts had has been eroded by the wide dissemination of investment frameworks used by Warren Buffet and Benjamin Graham. Therefore, pension funds that want to deliver value for their members should embrace, and not shun, the use of managers that have developed innovative investment methods. Additionally, asset managers must search for ways to access new information or new ways of processing information to deliver value for their clients.

Conclusion

Over the last ten years, investors across the globe have become much more sophisticated. Analytical standards have improved, and the market has become more efficient. The search for investment returns, particularly in the current lowreturn environment, has led to the development of elaborate frameworks for decision-making. Older frameworks of investing may deserve some re-examination due to the challenges asset managers have faced in outperforming their benchmarks. Modern methods of investing, such as the quantamental approach, have begun to gain prominence. To avoid funding the outperformance of other investors, pension funds may have to view this as a case of adapt or die.

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