Most Managed Portfolio Service (MPS) providers have the same ambition – to grow client money in line with risk taken, while beating the benchmark.
But there are different ways to get there. After all, it’s differences of opinion that make a market.
Parmenion Investment Management focus on producing strong, consistent, risk-adjusted returns to avoid ‘lumpy’ performance. In other words, we don’t want 5 years’ worth of outperformance in a 6-month window, or to give up meaningful gains in a short space of time.
As a provider of model portfolios, we can’t influence when money will come in or out. Keeping returns steady is key. Performance fluctuates, we know that. And with no sure-fire way to guarantee good performance, aiming for consistency can mitigate the risk of similar clients having different outcomes and experiences.
This takes disciplined repeatable processes, good governance, an experienced investment team, and diversification through our asset allocation or the funds we choose. By blending them carefully, we can be sure everything isn’t pointing in the same direction all at once.
But without strong returns, diversification only gets you so far. That’s why we look for investments that work well together and contribute meaningfully to performance.
To achieve our dual aim of achieving consistent performance, and wherever possible, outperformance , we build our solutions around four central investment themes:
- Quality: this focuses on the type of companies our selected fund managers invest in. Broadly speaking, quality factors are linked to aspects such as lower debt levels, economic moats or barriers to entry, reliable cash flows and higher return on equity. Generally, this should lead to a more robust and sustainable business that’s resilient in harder times and able to compound returns for investors over the medium to long term.
- Small Cap: moving down the market cap spectrum offers a few benefits - greater scope for higher returns (with higher risk), more opportunity for active managers to outperform the benchmark, and another layer of diversification. Quite often, risk-adjusted returns in the small cap space can be higher too. So while you are taking on more risk to generate the increased returns, the trade-off is favourable.
- Duration: this is a measure of how sensitive a fixed interest asset is to changes in yield. We like duration because it provides more of an offset to equities when they fall. Aside from generating an income, this a key reason we hold fixed interest in a portfolio. The flipside is that when interest rates are increasing, they will lose more value, but we think the trade-off is a good one over the long run.
- Emerging Markets: a bit like Small Cap, there is a higher risk premium in Emerging Market (EM) economies and an expected higher growth rate, which should lead to enhanced returns over the long term. This makes the asset class a good choice for the higher risk grades. There are also diversification benefits compared with Developed Market equities, through the broad range of economies within the EM universe.
Different themes will do better or worse depending on the economic backdrop, investor sentiment, geo-politics, central bank policies, and other factors. Looking at the economic cycle, for example, quality businesses ought to do better when growth is scarce or through recessions. Small Caps tend to do well when sentiment is higher and an economy is growing faster. Duration will do well through a slow down or recession, and when interest rates are falling or expected to fall. Emerging Markets are often in a separate cycle but may do better when global growth is higher or political risk more benign.
With so many moving parts, consistently getting the timing right is near impossible. In the same way that we blend asset classes or fund managers to create diversification, we intentionally lean into investment themes that ought to complement each other and do better or worse at different times.
Looking back over the last 20 years showcases this well. This simple table doesn’t capture magnitude, but the points are still clear. Across the periods shown, there is pretty much every combination of underperformance and outperformance by theme that you could make, with a tilt towards positive performance overall.
It is thankfully rare to have 3 themes go against us in a year, let alone all 4. Back-to-back instances of this through 2021 and 2022 have unsurprisingly hit risk grade performance numbers.
Each risk grade has a different level of exposure to the themes. Lower risk models will have duration as the main driver, as it is linked to fixed interest. The equity heavy models of the middle and upper risk grades will be more exposed to quality and small cap. In the higher risk grades, this is greater still, as fixed interest exposure continues to fall, Emerging Markets exposure increases.
The extent to which Emerging Markets has been out of favour over the last decade versus the previous one is worth noting. Lately, much of this has been linked to China – from Covid restrictions to trade wars, the property sector or tech regulation, there’s been steady stream of reasons for investors to avoid the asset class.
Our view is that these challenges are not necessarily structurally detrimental, so the long-term case for the Emerging Markets theme remains intact. With higher return potential, you must shoulder high risk and more variations up and down. The current down leg has been painful, but as with many types of market cycle, it can be a precursor for a strong rebound.
This article is for financial professionals only. Any information contained within is of a general nature and should not be construed as a form of personal recommendation or financial advice. Nor is the information to be considered an offer or solicitation to deal in any financial instrument or to engage in any investment service or activity.
Parmenion accepts no duty of care or liability for loss arising from any person acting, or refraining from acting, as a result of any information contained within this article. All investment carries risk. The value of investments, and the income from them, can go down as well as up and investors may get back less than they put in. Past performance is not a reliable indicator of future returns.