Outcome investing – passing fad, or here to stay?
The typical model of investment management has remained largely unchanged for decades. Portfolios split across asset classes are created in line with different metrics (including risk profile and age) and managed accordingly. In turn, the fund managers aim to beat their market benchmarks.
If it ain’t broke…
This model was effective for decades, until the global financial crisis. During that period, benchmarks ceased to be a good guide to returns; even if portfolios outperformed benchmarks in falling asset classes, investors still lost money.
While markets have recovered somewhat since their 2008/09 nadir, they are still typified by volatility and low returns and therefore benchmarks continue to be viewed with scepticism.
The post-crisis environment has produced a ‘new normal’, in which traditional sources of income are not paying out and the behaviour of assets and the relationships between classes have fundamentally changed. Consequently, investment strategies cannot follow typical ‘growth’ and ‘defensive’ trajectories.
Investing for outcome
Outcome investing seeks to remedy these challenges, by putting the needs of investors first while also freeing fund managers to pursue any strategy to achieve those ends.
Rather than offering individuals a potentially mystifying menu of portfolio building blocks (e.g. equities, high-yield bonds, etc.), asset managers structure investments according to desired results in respect of yield, capital preservation, loss and more.
Gavin Counsell, a multi-asset fund manager at Aviva Investors, is an advocate of outcome investing. He believes the average investor is primarily concerned with achieving their financial goals, not whether and how a particular asset can achieve them.
“Investors are far more interested in outcome than journey. To use an analogy, when you hop in a car, you’re only really concerned about getting from A to B on time – the underlying details, such as how the car works, are not so important,” he explains.
Talib Sheikh, portfolio manager for JPMorgan’s Global Multi-Asset Group, notes most investors think in tangible, rather than product-specific, terms. While a minority may want to invest in defined areas or assets, on the whole investors want a certain level of income, more money than they had last year, or to beat inflation. Outcome funds cater to such straightforward thinking.
“With outcome investing, investors have a clearer understanding of what they’re getting, and a better understanding of what to expect in the long-run,” Counsell says.
An investor-focused market
As fund objectives are explicitly dictated by investor goals, the bar has been raised for active managers as the onus is now on them to deliver. Counsell recognises managers need to act with more thought and commitment than previously, and portfolio construction skills are more important than ever.
While a challenge, many active managers are embracing the opportunity to unshackle themselves from potentially inhibiting benchmarks.
Sheikh believes an outcome approach is much more focused, and gives managers the freedom to think about the best mix of assets to achieve investor objectives.
“We have lots of flexibility with regard to asset allocation, and the ability to respond to volatility and changes in the business cycle more effectively,” he says.
“It’s also more transparent. The days of ‘we’re smart, give us your money’ are over.”
The transparency of outcome investing is likewise a theme noted by Counsell.
When portfolios are managed according to pre-agreed aims, investors know the returns they can expect, and when they can expect them.
Reviewing is consequently a simpler, more open process as a portfolio’s key performance indicator is whatever an investor chooses. As a result it is easy for investors themselves to see whether their portfolio is on course to deliver desired returns.
If investments are failing to produce desired results, the time has come to amend a portfolio’s composition, or alternatively find a new manager to achieve their goals.
“Outcome investing works best when investor and manager enjoy open dialogue, and there are high levels of trust between them,” Counsell says.
It is not just fund managers who are subject to new requirements. With the advent of outcome investing, investors must adopt a long-term horizon.
“Things won’t move in straight lines, and there will be periods of flat or even negative returns,” Counsell says.
“Investors must understand that returns are generated over a two–to-three year period.”
Sheikh recommends taking a medium-term view.
“Investors should expect to tie up their money for three-to-five years, and review their portfolio perhaps once a year. If they’re not prepared to do that, they should keep their money in cash,” he concludes.
Some may be deterred from outcome investing. A fund being ‘unconstrained’ could imply a greater willingness to take greater risks in order to meet objectives.
Nick French, head of UK wealth management at Russell Investments, responds that the new philosophy is not undisciplined.
“An unconstrained approach doesn’t mean managers pull out all the stops, and forgo risk controls entirely, funds should remain balanced,” he says.
“We’ve always been driven by client objectives, but an unconstrained approach is especially important in today’s unique environment. It’s the best way of responding to highly unstable markets.”
While outcome investing could be on course to becoming a standardised approach, Andy Davies, head of UK retail at Momentum Global Investment Management believes investors should aware of the limitations of the approach.
“Investors need to be sure the outcome they want can be met by the ‘solution’ they are invested in – they need to regularly reassess who the solution is serving,” he says.
Davies also warns risk controls will have to be relaxed in line with pronounced volatility, as portfolios with restricted risk exposure will struggle to deliver returns as volatility rises. Investors may end up with portfolios that sacrifice returns if their primary aim is risk control.
“A preoccupation with controlling risk has distanced the focus from delivering returns for clients and may have in fact simply developed investment solutions designed to serve the advice process rather than investor needs,” he concludes.
“Returns cannot come secondary to risk if, by going down that route, expectations are not met.”