Equity investing at a time of high valuations

November 9, 2018
| United States

Equities valuations have generally been high across the board in recent years, driven up by prolonged quantitative easing programs from central banks since the 2008 financial crisis.

As a result, many options for investors look expensive in the global equities space. Given that the sector can’t simply be shunned altogether, what can asset owners do in order to make effective returns without taking on too much risk, or diluting performance altogether?

Some context

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While funding levels of pension plans are continuing to rise to ever-healthier levels, most (if not all) of these investors still have some way to travel and therefore need growth assets delivering credible long-term returns.

Rising valuations have tested the ease of this process, squeezing value and pushing expected returns lower. This has also been coupled with a move towards passive investment vehicles which might provide the market return at a relatively low cost but have also caused an over-reliance on market beta for returns.

In our opinion, adding alpha and ensuring it remains a core element of a strategy can materially help improve expected outcomes on your growth assets, particularly in light of lower expected returns from the market.

The question is, how can pension funds do this?

Why a concentrated, multi-manager approach works

In a market where valuations are high, we have found investors can often find a dearth of opportunities in many sectors and geographies. When choosing an external manager, our strong view is that pension funds select those which possess more skill and focus. These are the managers more likely to deliver successful and credible returns.

We believe that this concentrated approach works well and managers with a focus on company fundamentals over market timing can produce better and more consistent results over time. The longer the bull market, the more this theory holds true as making big calls becomes increasingly difficult. Going defensive or reverting to cash could be painful in terms of lost returns.

Taking this philosophy a step further, we see many potential advantages to multi-manager fund structures, which create an added layer of diversification from the perspective of both risk and return drivers.

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A multi-manager approach gives managers the freedom to continue to seek out niche opportunities, while also protecting investors from concentrated manager risk. By adding managers who are looking at very different approaches, regions and sectors, we believe it is possible to build a portfolio that is incredibly robust across the entire cycle and that reacts well to a variety of conditions.

That’s not to say that adding more and more managers can continue to enhance performance at an ever-constant rate. In fact, the key risk to the multi-manager approach is adding too many managers together such that the strategy reverts to look like the market in terms of the returns it delivers. We believe that, if using managers running concentrated accounts each bringing their own style and philosophies, a portfolio of approximately ten managers should deliver the dual benefits of enhanced long-term returns over and above the market, and greater diversity which offers protection through the cycle.

This approach aims for managers’ autonomy to deliver a differentiated strategy, with minimal overlap and low risk of reverting to the market mean. Over the long term, we have found this approach works to great effect. The key is being able to correctly identify the managers undertaking an investment approach which is truly differentiated from their peer group, and then being able to isolate it within a portfolio.

At a time when many managers might struggle to deliver a track record of outperformance, we believe successful implementation of an equities strategy could significantly help benefit a pension fund’s funding level and its subsequent path to maturity.


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