By Jayson Forrest - Managing Editor - IMAP Perspectives
In a low interest rate environment, Brad Matthews (Brad Matthews Investment Strategies), Chris Lioutas (Insight Investment Consultants), Jerome Lander (Dynamic Asset/WealthLander) and Alan Logan (Marcona Partners) share their insights on growth opportunities for portfolios.
In a highly challenging investing environment, if there is one message that a financial adviser should give to their clients around risk in 2021, then that message, says the Chief Executive Officer at Insight Investment Consultants, Chris Lioutas, is that risk doesn’t have to be seen to be there.
Speaking at the 2021 IMAP Investment Management Conference, Chris says it is a common misconception that risk has to be seen for it to exist, yet risk happens across every asset class.
“For many people, until you see the risk, it’s like it doesn’t exist,” he says. “However, risk does exist and we have to understand it and account for it as part of the portfolio management process.”
Chris addresses risk with his clients by modelling real-life scenarios over certain periods, like the GFC or tech-wreck, as a means of talking about risk. And in instances where Chris is unable to directly test an asset over a certain period, like the GFC, he then discusses the qualitative aspects of that investment over that particular period.
“For example, it could be liquidity risk or it could be people risk and so forth. We talk to our clients about that. And once you start talking that through with clients, it becomes evident what the risk is.”
Yet despite talking about risk, Chris says he is not trying to dissuade his clients from taking on investment risk. Instead, he views it as an important and necessary process to ensure clients are fully informed and aware of the risk, before they take it on.
“Clients need to be comfortable about the risk and when they are, then we're happy to assist them with their decision,” he says. “But in most cases, I believe far too many investors today think they understand the risk involved with their investments, when they actually don’t.”
Alan Logan - Marcona Partners
Director - Brad Matthews Investment Strategies
Chris Lioutas - Insight Investment Consultants
Jerome Lander - Dynamic Asset & WealthLander.
For many people, until you see the risk, it’s like it doesn’t exist,” he says. “However, risk does exist and we have to understand it and account for it as part of the portfolio management process.”
When it comes to building a growth portfolio, how does Chris’ approach differ between a scenario that accounts for slightly higher inflation and one that factors in a significant rise in inflation?
“When you do play out scenarios, they do produce very different portfolio outcomes,” Chris says. “That’s why we have started having conversations with our clients, where we look at a range of inflation outcomes and interest rate changes, and how these would affect the type of portfolio we would carry for them, which would look very different. And that’s the type of conversation that some people get concerned about, because in the recent past, inflation hasn’t been a concern, so portfolio settings didn’t change the investment outcome, too much.”
However, Chris concedes that in a high inflation environment, a client’s portfolio setting is likely to be very different, depending on how much risk an adviser builds into it. This includes how much you think inflation is going to go up by and what you think the central bank reaction will be. Chris says all these factors will dictate a very different portfolio outcome on each of these scenarios.
Brad Matthews, the Founding Director of Brad Matthews Investment Strategies, believes the Reserve Bank of Australia has been “incredibly open in terms of its three-year guidance” on inflation. However, he believes that if inflation does become a problem within that three years, then that will be a shock to the market.
“But there would have to be a reasonably significant increase in inflation from the current level for that to become a problem,” says Brad.
However, for the Portfolio Manager at Dynamic Asset and Chief Investment Officer at WealthLander, Jerome Lander, the more important issue with inflation, is what sort of inflation do we get.
“We are already getting supply side/commodity-type inflation. In fact, we are seeing lots of inflation types,” Jerome says. “We’re seeing asset price inflation and we’re seeing commodity price inflation. What’s next? Do we see more of the same or do we see something different? Inflation type is a key issue and how we hedge that will obviously be different, as part of the portfolio management process.”
The good thing about alternatives is there is a wide spectrum of different quality opportunities in this space. If you can get into the top quartile managers, you can get great results. However, you need to have a research process and the experience to be able to assess those opportunities.”
Allocating to alternatives
In terms of of alternative assets, illiquidity is a huge issue and remains problematic in how to integrate them in a managed accounts structure. So, while there are some excellent alternatives available in the market, like real assets or private debt that is yielding 8-10 per cent, investors need to forego liquidity in order to take up these opportunities. However, in this low interest rate environment, are clients prepared to do that?
“It’s an interesting question,” says Chris, who concedes that accessing alternatives on platform with a managed account, does become problematic.
“That’s because with SMAs, there needs to be transparency with the liquidity at all times. Also, the ability to manage the portfolio, like rebalancing, becomes almost impossible to manage, because you have to take out the alternative investment in order to rebalance the portfolio. And the longer the portfolio isn’t rebalanced, the harder it gets,” he says. “And then there’s the problem if you want to take advantage of an opportunity but you can’t rebalance out of that asset.”
According to Jerome, alternatives are not without risk, but he adds that the important thing to remember when using alternatives is that you are diversifying your risk. He says that as long as you are getting a return for the risk that you are taking, and you can actually assess that risk, then alternatives have a place in an investment portfolio.
“The good thing about alternatives is there is a wide spectrum of different quality opportunities in this space. If you can get into the top quartile managers, you can get great results. However, you need to have a research process and the experience to be able to assess those opportunities,” he says.
Brad agrees that alternatives do come with risks and one of the biggest, he says, is the the lack of diversification of alternatives within retail portfolios. “The exposure to alternatives has been too narrow. The important thing to remember when using alternatives in a portfolio is to diversify them.”
And while Brad believes equities are going to remain the main source of wealth accumulation for the majority of clients, in terms of portfolio diversification in today’s environment, he adds that an allocation to alternatives need to be a part of an investor’s portfolio.
“But remember, the important thing to consider when using alternatives in a retail portfolio is to diversify them,” he says.
The exposure to alternatives has been too narrow. The important thing to remember when using alternatives in a portfolio is to diversify them.”
Safe harbour for growth opportunities
Looking ahead over the next 24 months, are there any safe harbours for growth opportunities in an investment portfolio?
Chris concedes to being relatively bullish with his outlook because he believes with the flood of liquidity coming into markets, coupled with large household savings rates and outsized cash holdings in money market funds, it’s hard not to be positive with risk assets, particularly equities.
“And that’s from a returns perspective,” Chris says. “It’s not that I think equities will do 30-40 per cent, it’s just that if inflation is a concern, where do you go for real returns? So, we’re optimist on this outlook.”
Instead, the critical question for Chris is where to place this money, as part of the asset allocation.
“We are bullish Asia emerging markets and have been for some time, but more so this year. We think the relative value on offer there is a lot wider than developed markets.”
And what about Australian equities? Chris believes large cap will probably struggle. In contrast, he prefers exposure to small and mid caps.
“We’re still positive on those niche asset classes where there is less research and less awareness. The more under-researched a market is, the more positive we’re likely to be, as long as we’re comfortable with the manager we’re using in that subset or part of the market.”
Given the risks and uncertainty in the world today, like inflation and geopolitical risks, Jerome’s safe harbour is gold equities, because of its contribution to reducing the overall risk of a portfolio.
And for Brad, he likes real assets, like infrastructure and some areas of property. He adds there is also some benefit in owning overseas currencies, which can be a reliable source of diversification
Alan Logan is Principal Consultant at Marcona Partners; Brad Matthews is the Founding Director of Brad Matthews Investment Strategies (BMIS); Chris Lioutas is Chief Executive Officer at Insight Investment Consultants; and Jerome Lander is Portfolio Manager at Dynamic Asset and Chief Investment Officer at WealthLander.