Before year end, we sat down with Sarah Quirke, Head of Investment Solutions, to discuss the key structural themes in portfolios for 2024.
How do we fit structural or other themes into portfolios?
There are many ways that structural themes can be introduced into portfolio construction. Traditionally, a structural theme could be reflected in a sector or industry tilt in a portfolio. For example, an innovation theme like AI could be expressed at a basic level via overweighting Technology or perhaps the semi-conductor sector specifically. Of course, single stocks could also be used to reflect a theme, but this would lack diversification and so be exposed to undue concentration risk. Increasingly, themes can be more precisely reflected in thematic collective investments (exchange traded funds or managed funds). For example, the structural trend to decarbonisation can be reflected more precisely, such as via exposure to a collective of companies focused on development and construction of alternative energy grid infrastructure.
There are other macro themes which can also play an important role in portfolio construction. For example, inflation or disinflation. These could be primarily reflected in fixed income exposure, where long maturity assets with fixed interest coupons would benefit more from disinflation, while shorter-duration assets with more flexible yields could suit more a structural shift towards inflation.
What are the other parameters that need to be considered and how do they affect portfolios?
Long-term expected returns for the major asset classes are critical for setting strategic asset allocations. These are used as a guide to risk and reward metrics for each risk profile. And they define the reasonable (but only indicative) objectives for the strategy embarked upon for each investor. Financial situation, attitude to risk, time horizon and objectives of the investor are very important in determining the right risk profile and this needs to match with the agreed objectives for the portfolio, as defined by the expected returns.
Many other key considerations come into play – any constraints or preferences, notably on Sustainability, or tax treatment preferences, or cost and complexity considerations. It’s a bit of a puzzle, but the right solution will always relate back to the core views and strategic asset allocations.
What defines success in terms of portfolio construction and the investor experience, in your view?
For a wealth manager, the single most important metric has to be delivery of investor objectives in absolute terms over the investment time horizon. On the day that a prospective client sits down with a portfolio or relationship manager and defines their attitude to risk, their preferences and aspirations, a picture can be formed of what a suitable strategy might be, what investments would be appropriate, and what the prospective returns could be from taking an estimated amount of risk in financial markets. Whether these goals are ultimately achieved or not is the principal metric of success.
Secondly, how have our asset class selections performed relative to pre-selected benchmarks? For example, if the investment research team chooses a basket of stocks, has this under-performed or outperformed the total return of the world equity index, all in euro terms? The same for fixed income, relative to the broad euro fixed income index.
Third, how have our portfolios performed against peers – i.e., specifically, wealth managers attempting to achieve the same goals as we are. Capital preservation is an important objective in this industry. So, growth most often needs to be achieved conservatively. Portfolio construction is a significant contributor to finding the right investment solution.
This article was originally published in the Goodbody Investment Outlook 2024: Going for (structural) growth publication on 4 December 2023. To read the full Investment Outlook publication, click here.