Andrew Sharp Paul: So the final kind of key theme from our client discussions is obviously resilience. How do you think about resilience? Other than the topics we've already talked about, how do you think about additional ways to build resilience or bring resilience into a multi-asset portfolio?
Steve Gorman: Yes, I think we haven't talked a lot yet about the security selection side of this as well. And so I think a proper process for teeing up those active management strategies as they relate to stock selection or bond selection is the last piece of this because, in addition to what I just said a minute ago about making sure that your risk budgets to these more top-down or more lumpy sources of active risk, that's going to be an important piece of it. But actually, your highest information ratio, your best return per unit of risk is going to come from the security selection side of the ledger. And that's really because the breadth of those decisions are so much wider. If you think about that return per unit of risk being a function of how many decisions can you make to capitalize on whatever edge you have, those managers just have more chances more chances to express themselves.
Whereas we may be good at tactical asset allocation, but the reality is the opportunity set is much smaller. There’s stock market, there's a bond market, there's sub decisions. So we want to get that manager selection decision right because that can be, pound for pound, our best source of pure alpha.
But all those managers come with the same considerations I mentioned a minute ago with respect to we have to tease out what parts of their presumed alpha is systematic or factor oriented, in this case, and what isn't. And essentially, the team goes through an exercise that is, it’s one that we refer to as three Rs. But you go through an exercise of, essentially, what's the role that each manager is going to play? What's the residual or alpha profile of that manager? And then the risk profile.
But the way to think about it in this context is we're going through a fairly specific process trying to tease out the risk profile of each manager, not just in units of tracking risk or active risk but also in what regimes does the manager generate alpha? You know, do they generate alpha equally in down markets versus up markets? Or do they tend to generate it when markets are well behaved? Do they have a skew, you know, stylistically? Are there apt to be certain environments in which they have a headwind or tailwind that actually another manager benefits from?
So there's a lot of marrying managers and their profiles once you've decided on the attractiveness of any given strategy. Then gets to a fit question in the portfolio. And part of this, this risk budgeting is trying to align that so that you can harness purely that idiosyncratic or pure alpha element. And you can do it in a way in which you've essentially stratified the risks of your various strategies.
Meaning some will have done well last year, some won't have, some will do well in a rate-rising environment, some will not. And essentially, through means other than just risk model output, you've also tried to stratify it along qualitative dimensions that have some empirical underpinnings, but they're not going to pop up in our risk models every day.
And that's more about balance. That's resilience to us, it's environmental resilience, regime resilience, alpha cycle resilience. There's a lot of ways we could frame it. But you're trying to land in these dimensions so that you just increase your odds of performing as a whole. So that's how we go through it on that side. And that is an important generator of alpha in these portfolios.
Andrew Sharp Paul: Interesting. So resilience through breadth, resilience through the right manager research process, resilience through the right manager selection, and the resilience ultimately through balance within your portfolios.
Steve Gorman: Yes, that's right.
Andrew Sharp Paul: And how do you think about the role of alternative assets within a multi-asset framework, so gold, hedge funds, private assets? How do you think about kind of expanding the opportunity set as you speak to clients and as you manage client portfolios?
Steve Gorman: It's the same process for us. So, you know, if you're evaluating a hedge fund manager or even a privates manager, you still want to go through the same three R framework that we talked about a minute ago. That sort of role, residual, and risk assessment. And you would also go through the same breakdown of their return profiles that I mentioned a minute ago, which is kind of implicit in that process.
But for a hedge fund, for example, we're going to try to disentangle, just because it is a hedge fund it doesn't necessarily bring resilience or complementarity to a process if it's a very directional, long/short manager. We're going to want to tease out what is the beta piece and what is the beta profile from what their truly active offering is and then assess its complementarity.
So it's really the same process. And, in fact, we try to put all alternatives on a liquid asset equivalent basis. Meaning if you run a hedge fund, I'm going to try to figure out what your beta footprint is and how that maps to sort of traditional asset classes, and then look at your active risk through the same lens that we would look at a large-cap growth active risk manager.
Andrew Sharp Paul: So, that allows for a better apples-to-apples comparison when you're thinking about capital deployment.
Steve Gorman: That's right. And we do the same thing with privates. You're going to tease out whatever its liquid beta footprint is. Now, their active risk is a little bit different animal just because these are privates and these are valuation-based portfolios. But you're essentially going through the same exercise.
And as you move out on the ledger, the only other consideration becomes, I mean on the alternatives ledger, is liquidity and dealing terms. You know, obviously one of the other constraints then becomes, if you're into hedge funds, there's a certain dealing-term reality to that or a certain tradability. And with privates, it's even more important because then there's also a funding aspect to it. So, all of this is still part of extending the existing framework. It's just you do have to bring a couple other dimensions into it, at least for portfolio construction purposes.
Andrew Sharp Paul: Well, thank you, Steve. Thank you for being so generous with the time and sharing your insights with all of us.
Steve Gorman: Happy to do it.
Andrew Sharp Paul: So, just to summarize some key points there. So, first is focus, thinking about the way you deploy risk across your portfolios. The second is flexibility. Think about flexibility at different layers within asset allocation and decision-making within the portfolio. And then, finally, resilience. So building on those first two points which already have some resilience embedded in them. But think about other ways to build resilience in a multi-asset portfolio over time.
So thank you all for joining us again. Look forward to diving deeper into more of these topics in future episodes.
