Finding the right strategy in difficult markets

Thursday 8 June 2023


Author: Maha Khan Phillips

Marie Dzanis is Head of Asset Management in EMEA for Northern Trust Global Investments. In CFA UK’s ‘In Conversation Podcast’, Marie talked to Maha Khan Phillips about difficult market conditions, how investors are looking at their active and passive portfolio construction, and how they are considering factor exposure in their approaches.

The investment industry is facing a challenging time, with a host of issues from geopolitical risk, divergence and regulation providing plenty of headwinds. Speaking on CFA UK’s In Conversation podcast, Marie Dzanis, Head of Asset Management in EMEA for Northern Trust Global Investments, talked about the difficult landscape ahead.

“We have gone through the pandemic to the endemic, from globalisation to regionalisation, and the reality is that investors must navigate a challenging global economy with looking at high debt and unfavourable demographics. So we would say this is a theme of slow transitions, and slow transitions right now are likely to lead to slow growth,” she said.

Investment Approach

It means that getting investment strategy right is vital. “Investors are looking for clarity and ensuring that they have their portfolios shored up for what they need to do and how to better achieve their outcomes.”

Marie says there’s a critical role for both active and passive management in the current market.  “Investors move through different market cycles and they make decisions on both. You hear things like passive strategies tended to be more desirable when the economy may be volatile or weakening, or people seek active strategies but go for passive price, so the reality is that you need both, and frankly a good active manager is worth its weight in gold,” she said.

Marie compared the process of choosing a strategy to what cutlery to pick at the dinner table. “You have different tools for different foods. The debate may be less about one or the other, but who to use and when to use both in a portfolio.”

She highlighted the role of factors to actively design a portfolio with passive implementation. “Factors in general, capturing the premia is largely a behavioural effort. For example, investors are looking for short run profit where there’s a bid up the price of high volatility stocks. But from the behavioural aspect you also want to mitigate herd mentality of implementation of that in your portfolio, so you want to get rid of those behavioural biases, and that’s why [you] want to actively design but passively manage.”

Portfolio Construction

Marie also cited the importance of time horizons, strategy, and levels of transparency, as key considerations. Large institutions often believe they need to manage in perpetuity, she said, and the philosophy for them is about reversion to the means over time. 

“When [they’re] managing over a longer time horizon, they believe that dispassionate implementation of their strategy without the risk of having a portfolio manager having behavioural bias creeping into the strategy and messing with the timing, is a better way to implement. Then there’s also transparency. Passively implemented strategies are very popular with those that want instant transparency on holdings. And so we see this a lot, for example with ETFs. So depending on the strategy and manager, an active strategy can be non-transparent and the holdings can have a delay after the reporting period especially in a volatile market where there is concern on who has what exposure, that may or may not be attractive depending on what they want in the portfolio. So there is some for all, but you can see with those lenses of time horizon, transparency needs, immediate exposure needs, that can play in who you choose and when.”

But investors also need to be compensated for the risks they are taking. Marie pointed out that the Capital Asset Pricing Model shows that beta historically explains about 70% to 75% of returns. “So if you’re looking to capture the most of your returns in a portfolio, you want to be very sharp. Use the right tools in the portfolio. Then we saw in 1992 Eugene Fama and Ken French expanded on this by adding size and style value to be able to explain better than 90% of the returns. So again, sharper tools in the portfolio, better explained.”

Factor Exposure

The role of factors in unlocking a portfolio can be transformative, but there are key considerations for investors. “There are some skill factors depending on an investor’s clarity of definition, and there are some risk factors that are in a portfolio. The skill factors look at the empirical evidence to support the factors. Are returns consistent through time and across markets? Is the factor justified on theoretical grounds and will that persist in the future? Looking at things like this is critical.”

The other question Marie is often asked is about opportunities to arbitrage away the risk premia. “[It’s] really interesting because it’s becoming less homogeneous in behaviour. Investors, while they are becoming smarter and having more access to information, actually become more differentiated in their objectives and their constraints and their risk preferences. So factor premia might be actually more prevalent in the future for the market.”

Marie also highlighted the importance of taxonomy and transparency when looking at factor approaches. She also discussed how data and technology is changing the landscape, and some of the challenges it presents. “The volume of data is enormous and it’s difficult for any firm or any entity type to digest it all. The quality of data isn’t necessarily always great in general, the proliferation has been among low quality data, but there’s still an opportunity for upside and earning and better reporting. AI and machine learning can solve some of these data quality issues but they certainly can’t do them all. What we use today AI technology for is the factor in risk assessment, the factor construction, better portfolio construction overall, things like optimisation and constraint attribution, these are just to name a few. So I think there’s a lot of opportunity to incorporate these in the portfolio and we get better and better as an industry with culling the data and getting more information. And that’s exciting and has wonderful implications for the use and application in portfolios and beyond.”




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