By Jayson Forrest
The implementation of risk management strategies in managed account portfolios can be challenging. Uwe Helmes (BlackRock), Simon Ho (Milliman), Glen Foster (Atrium), and Andrew Stadelmann (BT) discuss their approach to risk management.
Andrew Stadelmann
BT
Uwe Helmes, CFA
BlackRock
Glen Foster
Atrium Investment Management
Zac Leman
BT
Simon Ho
Milliman
Risk isn’t a bad thing. In our growth portfolios, we don’t like diversification. If we have conviction in a manager, we want them to pick the best 20 stocks. So, if you’re willing to take on that risk, then pick a manager or a couple of managers. But understand that having high conviction with 20 stocks means you’re taking on a lot of risk
Risk management is an essential element of investing and portfolio construction. It involves identifying, analysing, and accepting or mitigating uncertainty in investment decisions. At its core, risk management is the process of monitoring and dealing with the financial risks associated with investing.
However, implementing hedging strategies as part of risk management in a managed accounts structure can be challenging, says Glen Foster — Head of Risk and Senior Portfolio Manager at Atrium Investment Management. Currently, Atrium runs about half of its funds in managed accounts, yet when it comes to managing risk, Glen concedes there are a number of constraints in using managed accounts. One such constraint is not being able to buy derivatives directly in this type of structure, compared to a unit trust.
However, Glen says the industry is increasingly finding solutions to overcome these constraints. At Atrium, for example, it uses ‘access funds’ — a vehicle it has set up on platform — which holds one or more managers.
“We have one ‘access fund’ that holds just global long/short equity market neutral managers, and within that, we can hold derivatives,” says Glen. “So, by using these ‘access funds’, we have much greater flexibility in managing risk. We can hedge currency and use put options to help shape our portfolios.”
Speaking at an IMAP Independent Thought Roundtable on risk management, which was hosted by BT, Glen acknowledges that in terms of meaningful overlays for portfolios, bigger ‘access funds’ are required. That’s why Atrium is moving towards a core equity vehicle, “because equities are where most of your risk is, so that’s where you tend to want to do most of your hedging”.
“Within that you might want to then allocate some of the risk budget to hold put options, or hedge a currency, or even add some assets with interest rate sensitivity that might be missing from the rest of your portfolio,” says Glen.
BlackRock takes a different approach to implementing risk management strategies within its managed account portfolios, says Uwe Helmes, CFA — Investment Strategist at BlackRock. He adds that where BlackRock has flexibility with mandates, derivative strategies can make a lot of sense, but agrees that within a managed accounts structure, derivatives are hard to do.
“Instead, as a hedging strategy, we look at other asset classes, like gold, where you can get a good exposure quite cheaply. So, in periods of market stress when asset classes become closely correlated and you want diversification to kick-in, gold is an asset you can access easily and it serves as a good diversifier in periods of market stress,” says Uwe.
“We also use currencies, as well as tactical tilting. Our managed account clients value the flexibility of tilting the portfolio in periods of market stress, where we put tactical tilts in place to de-risk the portfolio — like moving out of equities into cash.”
Because equities are where most of your risk is, that’s where you tend to want to do most of your hedging. Within that you might want to then allocate some of the risk budget to hold put options, or hedge a currency, or even add some assets with interest rate sensitivity that might be missing from the rest of your portfolio
Risk isn’t always a bad thing
However, Andrew Stadelmann — Researcher and Managed Accounts Specialist at BT — accepts that not all portfolios are risk averse, and some portfolios actually seek risk. In such scenarios, he says it’s important to remember that the adviser is managing the client’s personal risk, whereas the investment manager is managing the investment risk.
Glen agrees, adding that advisers are best placed to ascertain the risk appetite (the amount of risk a client is willing to accept or retain in order to achieve their objectives) of their clients. “My job then is to build a portfolio that stays within that risk appetite, whilst working within the risk tolerance (the levels of risk taking acceptable to achieve a specific objective or manage a category of risk) to the objective of the risk appetite.”
Uwe believes the adviser plays a crucial role to ensure their client properly understands the level of risk they are getting into with their investments, as well as to make sure that the asset manager or product provider delivers on what they say they will do within the portfolio.
“Risk isn’t a bad thing,” says Uwe. “In our growth portfolios, we don’t like diversification. If we have conviction in a manager, we want them to pick the best 20 stocks. So, if you’re willing to take on that risk, then pick a manager or a couple of managers. But understand that having high conviction with 20 stocks means you’re taking on a lot of risk.
“If you can stomach that risk to maximise your returns, then maybe that’s exactly what you need to be doing. However, by blending 10 or 20 managers together, you’re going to be lowering your active risk. So, it really depends on the client and their appetite to take on risk. Advisers need to put clients in the most appropriate portfolio for their needs and objectives.”
Whilst Milliman’s portfolios are designed primarily for pre-retirees and retirees, Simon Ho — Senior Portfolio Manager at Milliman — says advisers also place accumulator clients into these portfolios, particularly in the high growth portfolio.
By doing so, Simon says it provides both advisers and clients with comfort knowing that if a tail risk scenario happens, they are able to mitigate the risks. “They also value the more stabilised volatility that our portfolios provide. At the end of the day, it’s about clients achieving a higher risk-adjusted return, while also enabling accumulators to maximise their return with the sleeve of risk they take on.”
The potential application of using AI is good, particularly when disseminating all the options available on a platform. But reading the current iteration of AI generated ratings and reports, it’s obvious to see the issues with machine generated reports. So, in terms of the use of AI, I think we’re still a fair way off the mark in regards to investment governance
Strategies for tail risks
And what about tail risks? With ongoing market volatility and geopolitical issues, BlackRock is focused on a number of strategies that deal with tail risks.
According to Uwe, when investing, there are always tail risks — some eventuate, while others don’t. However, what keeps BlackRock up at night is geopolitics — China/Taiwan, Russia/Ukraine, and Israel/Palestine.
“These geopolitical issues can have an impact on markets if they escalate, so that’s a tail risk. And then there’s the likelihood of a recession. Most people think we are in a ‘soft landing’ environment, but that’s also a tail risk. When markets price certain things in, it’s the unexpected that people need to worry about.”
So, how do you hedge against the unexpected? Uwe believes there are a number of strategies that can be used. BlackRock favours alternative strategies, like commodities, as well as strategies where both defensive and active managers play a role in the portfolio.
“We’re also looking at bonds,” says Uwe. “Bonds don’t seem to provide the same level of diversification as they once did. So, being nimble and creative when it comes to diversification is key when dealing with tail risks, and there are plenty of strategies available that advisers can utilise.”
At the end of the day, it’s about clients achieving a higher risk-adjusted return, while also enabling accumulators to maximise their return with the sleeve of risk they take on
Approach to market downturns
Ask Glen about a recent example where his approach to risk management protected client portfolios during a market downturn, and he uses 2022 as an example, when bonds fell alongside equities and couldn’t be used as a portfolio diversifier.
“During this time, there was a period when both bonds and equities suffered negative returns. But there were other assets — like commodities and FX — that did help during this time. Our liquid alternatives sleeve was up 15 per cent over that period, which helped to diversify the portfolio.”
During market downturns or shock events, Uwe believes it’s important for managers to be dynamic, as was experienced with the February 2022 invasion of Ukraine by Russia. Responding to the invasion, BlackRock rebalanced its managed account portfolios within a week, which helped to protect its portfolios from the subsequent downturn in the market.
He also cites 2022 as being a learning opportunity for the industry. While BlackRock’s position on bonds was right, the sheer magnitude of the sell-off across almost every asset class was significant, making it a tough year for asset managers.
“When it comes to risk management, the more levers you can pull, the better,” says Uwe. “Whether that’s through active managers, style, or having a dynamic approach with different managers, these can all be valuable levers to use for managing risk.”
Simon agrees that 2022 was a challenging year, when bonds fell alongside equities and failed to act as a diversifier in portfolios. Compounding issues for Milliman was the fact that whilst its strategy managed risk on the equity side, it didn’t on the fixed income side.
“So, this meant our lower risk portfolios, like moderate and balanced, drew down by about the same amount — perhaps even a touch more — as our growth and high growth portfolios,” says Simon. “Not surprisingly, this made for some interesting client conversations.”
When it comes to risk management, the more levers you can pull, the better. Whether that’s through active managers, style, or having a dynamic approach with different managers, these can all be valuable levers to use for managing risk
Looking forward
With risk management being a forward-looking discipline, how do managers factor in the unknown — like climate change and stranded assets — when unable to draw upon historical data or precedence in relation to the impact on returns?
“It’s a good question,” says Uwe. “When considering climate change, it helps to use the available data on climate to try and model the impact of climate change on sectors and markets. Ideally, you model certain scenarios, like temperature increases, and work with that information.”
However, Uwe concedes that forward-looking assumptions don’t look like they are capturing the true impact of what could potentially happen to assets and asset classes. “Some mega trends have not been priced in yet, and that’s something the market needs to be aware of,” he says. “Markets are generally not good at pricing in mega trends.”
Looking forward, Uwe believes the likes of artificial intelligence (AI), machine learning and big data will all impact risk management and how portfolios are managed in the years ahead. He says the use of AI to process data quickly and efficiently will only accelerate over the coming years, and help reduce the cost of advice.
However, Andrew remains sceptical, adding that there remains glitches with the use of AI. He points to a prominent financial services company that has rolled out AI generated ratings and reports, which has experienced teething issues.
“The potential application of using AI is good, particularly when disseminating all the options available on a platform,” says Andrew. “But reading the current iteration of AI generated ratings and reports, it’s obvious to see the issues with machine generated reports. They are not providing the same quality of research and reporting that a human generated report can provide. So, in terms of the use of AI, I think we’re still a fair way off the mark in regards to investment governance.”
About
Uwe Helmes, CFA is Investment Strategist at BlackRock;
Simon Ho is Senior Portfolio Manager at Milliman;
Glen Foster is Head of Risk and Senior Portfolio Manager at Atrium Investment Management; and
Andrew Stadelmann is a Researcher and Managed Accounts Specialist at BT.
They spoke on ‘Risk management’ at an IMAP Independent Thought Roundtable in Sydney, which was hosted by BT.
The roundtable was moderated by Zac Leman — Head of Managed Accounts at BT.