When the history of 2020 and Covid-19 is eventually written, it will be seen as a year of huge disruption and potentially a driver of significant long-term change. With the pandemic overshadowing all other events over the last nine months, however, it is easy to forget that investors were already preparing for 2020 to be a year of enormous change.
We had just come out of yet another election in the UK in December 2019, which returned a majority Conservative government under Boris Johnson’s leadership. How long ago that seems now! 2020 was therefore expected to be the year when Brexit negotiations and transition dominated the news agenda, along with a potentially disruptive US Presidential election in the fourth quarter.
Closer to everyday life, by the end of 2019, we had already started to see the disruption on the High Street, with major and well-established retailers such as HMV, House of Fraser and Debenhams (the first time) going into administration that year. Indeed, according to the Centre for Retail Research, almost as many employees were affected by retailers going bust in 2018 and 2019 as they have been in pandemic-hit 2020.
Structural and seismic change
I mention retail because it is a good example of an industry impacted by changes that, at the turn of the decade, were clearly structural and seismic in nature. Twelve months ago, we were making plans based on a world where significant change was evident and underway. For instance, tensions and indeed trade wars between China and the US were emerging as China continues to develop as a global superpower.
Across the globe, the world’s population is ageing, with all the benefits this brings to those industries catering to the wealthy old – or the ‘young old’ as the Japanese refer to people aged 65 to 75 – and all the challenges it brings to governments providing social care.
Demand for sustainable economies is increasing, with the growth of renewable energy and electric cars and away from carbon-intensive industries, causing the Bank of England to warn of considerable transition risks.
And, of course, arguably underpinning it all is the inexorable rise of digital across all industries – with e-commerce, robotics and artificial intelligence not only accelerating the death of the High Street but increasingly being used to provide access to new services, such as streaming video, taxis and food on demand.
Perhaps the major impact of Covid-19 for investors has been the fact that these structural changes, which we might have reasonably expected to play out over 10 years, have been compressed into 10 months – rather like tectonic plates, which normally crawl along at a snail’s pace, suddenly speeding up. The pandemic and global response to it this year has accelerated the process of creative destruction, both creating new opportunities while destroying existing ones.
So, how does a portfolio manager and adviser navigate this environment, when there is not only political and economic disruption all around, but so much structural change at the same time? In a changing world, the investor’s risk target represents the ‘true north’. While ‘magnetic north’ may wander around – apparently by more than 1,400 miles since its discovery in 1831 – true north remains static: it is the northern-most point on the earth’s surface; the axis around which the globe spins.
Focusing on delivering portfolio returns for an agreed level of risk over the longer term gives the portfolio manager and investment adviser a true north against which to make long term allocation decisions.
Asset allocation remains key
As I and many others have referenced before in this space, asset allocation has been shown to address 90%-plus of the variation of portfolio returns over the long term. Understanding the potential risk and return of each, setting a risk budget agreed with the investor, and holding a steady course has over the last decade and a half been shown to have a positive impact on returns.
Why should this be? Why focus on risk to boost return? It can feel counter-intuitive, but there are three key reasons. The first of these is that optimising on a forward-looking or ex-ante view of risk provides a framework grounded in the requirements of the investor, which is not subject to the ebb and flow of investment fashions, with all the associated transaction costs and time out of the market or key asset classes this can entail.
Secondl focusing on risk provides an investor-centric framework for a shift away from the UK toward global diversification, in a world in which the search for return is harder. According to the Investment Association, allocations to UK Equity funds have declined substantially as a proportion of total UK investor funds under management (FUM) in the last 15 years, falling from 39% of FUM in 2005 to just 14% by June 2020.
Finally, tracking longer term, asset allocation-based positions on a more passive basis reduces costs, with a consequent positive impact on returns. In its September report, the Investment Association remarked that this has not been lost on investors or managers: funds under management in indexing funds were up 26% between year-end 2018 and 2019, and since 2014 nearly half of retail sales are to index trackers.
Commercial and regulatory drivers
There are of course also systemic commercial and regulatory drivers, focused on investor outcomes, which align to the ‘risk as the true north’ approach. From the commercial perspective, for example, clients clearly want returns, but most will value avoiding unnecessary losses even more. Money is therefore ‘stickier’ if it delivers on investor expectations, particularly in retirement.
Meanwhile, the regulator’s investor protection agenda defines value for money as the return provided for the risk taken, after charges. The result, according to the Investment Association, is that the proportion of total net sales to outcome and allocation funds has risen from 23% in the decade before the global financial crisis to 43% since 2009. The Volatility Managed sector was one of only six sectors to see an inflow in March 2020.
Sustainability characteristics
In addition, from next year, ESG or sustainability characteristics will need to be incorporated when considering client outcomes. The FUM in responsible investment funds grew by 89% between January 2019 and June 2020. This increase meant the RI share of industry FUM rose by over 70% over the 18 months leading to June 2020. Using a risk-based benchmark makes it considerably easier to reflect client ESG priorities than, say, attempting to replicate the FTSE without certain key investment types. Advisers can have more flexible and personalised conversations with clients and tailor portfolios according to any specific preferences, while still sticking to the agreed risk benchmark.
So, at a time of significant change, using risk as the ‘true north’ in client planning and portfolio management should deliver better client outcomes and, as a result, mean that their funds are stickier. A situation where, even after the disruption of 2020, everybody wins.
Ben Goss is CEO of Dynamic Planner
