Andrew Sharp Paul: Hi, I'm Andrew Sharp Paul, APAC Solutions Director for Wellington Management. I'm joined today by Steve Gorman, Co-Head of our Multi-Asset Portfolio Management team. Today, we're going to dive a little deeper into some of the topics we discussed on the earlier video, specifically, focus, flexibility, and resilience within a multi-asset portfolio. So first, we're going to talk about focus, specifically, how do you focus active risk within a multi-asset portfolio? So Steve, you manage a number of different multi-asset portfolios. How do you think about deploying active risk, especially in today's challenging environment?
Steve Gorman: Our first initiative when we're thinking about active risk is breaking down what constitutes the active risk. So, for us, as you know, Andrew, it's got to be true active risk. And so, that basically involves teasing out what we consider the more systematic or factor-oriented elements of active risk versus what we truly perceive to be idiosyncratic or "alpha."
So that's a fairly deliberate process for us, because every active management process, be they hedge funds, equities, fixed income, etc., they're all bringing some of this systematic baggage to the table.
That's the stuff that we typically don't want to pay for, can end up being correlated when we put together different sources of active risk, and it's actually prone to some of the most serious pullbacks or drawdowns.
So, we have to basically figure out what the fingerprint is of every active strategy. And once we've separated that potentially common element from it, then focus on essentially a process for determining the nature and quality of the active positioning, which I can get into in a second.
Andrew Sharp Paul: So, put differently, thinking about ways in which you can ensure that any risks you're taking in the portfolio are deliberate or hopefully compensated, and kind of mitigating some of those uncompensated or unintended factor risks within a portfolio.
Steve Gorman: Yeah, and sometimes we refer to them as passenger exposures or passenger risks. And it's not even that they're all uncompensated. Some of them are actually compensated, but they're redundant.
Your portfolio may be picking up very similar risks in its underlying, say, equity weighting. And so, getting more of that in your active return streams isn't necessarily what you're after from the outset.
So, it's almost purifying the exercise so that you then can focus on what does diversification really look like for us within the realm of what we consider idiosyncratic risk.
Andrew Sharp Paul: And how do you think about that in a framework, an SAA framework versus a total portfolio approach framework? How does that differ on that scale?
Steve Gorman: Interesting concept. So in an SAA framework, and for those that are less familiar with it, the SAA framework would be a strategic asset allocation framework where we're typically thinking about a longer-term set of exposures to traditional asset classes. That would be your strategic asset allocation.
Whereas something like the TPA or total portfolio approach, as you know, Andrew, it actually defies a single definition. So, it's hard to put a single name around it, but it's a bit more outcome- or objective-oriented in its nature. It has some different elements with respect to the governance of it, its view of the role of SAA. And, as a result, there, they appear to be very different setups. But in our portfolio, given what I just said about how we disentangle active risk, there's actually more commonality than not.
And so, we have this discussion internally from time to time around is our process consistent with a total portfolio approach? And I believe it is, because I think the active risk-budgeting piece, whether you ascribe to one or the other, the active risk-budgeting piece is going to come down to some of the same fundamental determinants that I mentioned.
You're still, for every strategy that you invest in, every active set of risks that you look at, you're going to have to distill what's systematic and what's idiosyncratic. You're going to have to determine how both fit with your overall objectives, whether that's tied to a strategic asset allocation or tied to an outcome in your TPA world. And then you're going to have to decide on what the appropriate levels of diversification and the appropriate guard railing is when you go through this risk-budgeting exercise.
So, while they're ostensibly quite different, I actually think when we attack the problem, the attack plan is actually fairly similar. It's just, in the total portfolio approach, you've kind of pulled the strategic consideration out of it. You've said we, as a governance board, are not interested in dictating what the SAA should be. We're relying on you to do that or not to do it, depending on your view of the efficacy of that problem.
But you're still putting on our plate the same sort of objective orientation that we have to deal with in either situation.
So, again, I think they're more similar from an exercise perspective in our world than might be at first apparent when I see it in the literature talked about as two distinctly different investment approaches.
Andrew Sharp Paul: I get asked that question a lot around SAA versus TPA. And I suppose my view is always that there is a spectrum, there's a scale between. It's very rare, or I am not sure if it exists, if someone is purely SAA or purely TPA. It's all about how much you kind of lean into those various concepts. But I agree with you, it is ill defined. And I think it's very rare that someone would do one without the other. It's kind of how much you emphasize each of those concepts within your structure.
Steve Gorman: I agree, and I also think that one of the challenges, how different they are, we will see over time with respect to how they come down on portfolio performance evaluation, because the rubber always hits the road with respect to the performance assessment portion of it.
And if TPA, if that approach gives you, at least at the outset, more wiggle room, what I think has yet to be clearly defined in that space is how are you going to do the opportunity cost assessment that is, you know, follows us and our strategies, even in a total return mandate, when secondary benchmarks pop up for other things?
And as much as the TPA can try to distance itself from that, it is really tough if your portfolio hits its objectives and the casual observer, whomever your oversight body is, looks at equity markets, for example, being up 20% in a year, and your portfolio has printed some lower numbers, still in line with your objective, and they start asking why wasn't it better and how could it have been better?
So, it'll be interesting to me to watch that space evolve, because the space gives you more latitude on the spectrum you mentioned. But ultimately with the term, I think the breadth to which that takes, that TPA approach really takes, is going to be how we cross this performance assessment hurdle kind of bridge.
Andrew Sharp Paul: Just for the avoidance of doubt, when we talk about TPA, it’s typically more of a total return-oriented approach. We think about SAA, it's more benchmark relative. So, what you're saying is you kind of need to make sure you’re aligned structurally, philosophically with the kind of investment return you’re looking for, whether it’s total or benchmark. You need to basically stick to that.
Steve Gorman: Yeah, and even in an SAA world, as you know, the total return mandates that you mentioned, some of them, they break down as well into subgroups where they’ve said, okay, we want you to own this total return responsibility.
And it's sort of implicit if we want to use SAA or not use SAA, we decide how much SAA risk to embed in those portfolios based on our own convictions about what value it does or doesn't add for that client.
And then you have others who, they kind of like the sound of that, but they still want the comfort of a secondary benchmark, and then it becomes more benchmark-relative, to your point.
So, that same spectrum problem that you mentioned earlier, we live with on the total return side as well, which is why this, to me, feels like just another element of that broader spectrum under the broad umbrella of total return-oriented mandates.
