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Gary Dugan, the CEO of The Global CIO Office, spoke to Stefan Wagner, Head of Business Development at vestr, on NaluFM Finance about all things related to active investment portfolio management:
Tune in as Gary debunks the 60/40 Portfolio myth and defines the differences between investment, speculation and betting.
It is a group of CIOs. We want to act as the investment department of EAMs and multi-family offices, and provide services into single-family offices. Our current client base is a healthy combination of family offices and small wealth management businesses.
Some people are realizing that you need expertise, and it doesn’t come cheap. You don’t always need a CIO for the full year. Instead, you might need them for a few hours a week. As such, we are an outsource CIO services model.
If you’re working for the principal, it is very difficult to put up new ideas because you might lose your job. So, we can be that external advisor and can actually offer some good ideas.
Example: Your asset allocation today just references 2 or 3 assets. Particularly, it is things like private equity or their industrial holdings and it is real estate. It is not private depth markets, venture capital, pure equity market and in different parts of the world.
Everyone says, “I want to invest in the S&P 500, have you heard of China.” Its an ongoing problem, the biggest issue for many of those single-family offices is asset allocation and it is anchoring in the past.
That’s fine when you’re talking to a machine but when you’re talking to human beings, emotions come in. I always liked the concept of behavioural finance because that’s what creates economic cycles.
One way of controlling that is saying: “We’ll look after X% of your portfolio. For your own whims, ideas, or bets, we will give you 10% of your wealth or 5% of your wealth. Go play with that, but once you start to mix those two things together, you’re in trouble.”
The way I’d like to think about it: there is no normal distribution of risk. First thing I say to people: what’s the upside and downside risk, i.e. what is the skew. Helping them understand that there is just easy upside and downside of equal value.
Second way we try to control risk: how confident are you? For example, anyone can say the S&P’s are going to be up 10%, but what are the other outcomes and how confident are you about your call? Then I think you start to control risk.
Risk comes in many different formats. People look at portfolios today and think: I just don’t need these fixed income securities. They’re going to lose me money. Everyone tells me that the 10-year yield in the US is going to be 3% so why should I hold fixed income?
Remember Covid-19? Remember the crashes we’ve had in the past based on circumstances you’ve never thought of? That’s why you must have a diversified portfolio and that’s why you must still be holding assets that you think will lose you money.
Risk is not one-dimensional – definitely not a standard deviation – it is multi-dimensional.
Regarding our work in the wealth industry, we try to avoid the position where you get an emotional outcome from the clients. That plays very much on how much risk you’ve taken. E.g. with draw down here or not just telling people one, two or three movements down in terms of potential risk.
Very diversified portfolios, where you try to cover off the risks that you see, would lead to a catastrophic outcome for the portfolio. If you can mitigate that risk, then I think the balance for your portfolio is right.
Unfortunately, what tends to happen, is a client asks how can I make them as much money as possible. The two are incompatible. You are going to take that kind of bet on making huge amounts of money for your client. It can always come back to bite you in equal magnitude for the downside.
I’ve gone through so many different models. I started my career at the National Coal Board pension fund. The approach there for everything – every purchase, every sale – was to do it on either rising relative prices on the selling side or falling relative prices on the buying side. And as an institution, we are extremely patient with what we’ve done.
Unfortunately, over the decade, patience has gone out the window. These days, we are almost forced to commit the money straight away. However, if I can, I try to get the client to agree to give me a three-month window. Hopefully, we will average it almost automatically into falling prices, if you’re committed to the market. But the aim would be to average pricing over a short window.
What we try to do is called rebalancing. It’s just to have a really good deep dive formal look at the portfolio about once a quarter. But what we normally do is just have a kind of tech background that’s telling us when, for example, certain securities are moving by inordinate amounts.
I think often people just get trapped in seeing something that’s volatile move in a volatile way and they react too quickly to it. It has to be in an extraordinary way for you to react to it. If you keep that balance right, then you shouldn’t have to reshape your portfolios too often. I don’t think you’d really want to change your portfolio more than once or twice a year.
In my opinion, one of the free lunches that has been out there some time – although it’s getting whittled away – is the illiquidity premium. I get quite disappointed with a client when he doesn’t understand that you don’t need daily liquidity when you’ve already committed to this mandate for the next 5 to 15 years.
I know private debt has a bit of a dirty name given some of the scandals that have gone on in recent times. But there are private debt funds that give you that monthly liquidity. People balk at it. And yes, I can offer you an opportunity in an investment that gives you a 7% yield, which has been done every year for the last 15 years, but you have tie in money up for 28 days. I don’t think that’s an opportunity, but rather I see it as an enormous amount of risk.
I do say to people, you’ve got to take the illiquidity premium monthly or quarterly. We can also look at private equity that locks your money away for the next 5 years. I don’t like it when it locks away for 7 to 10, as some of these vehicles still do. But if you’re just in liquid markets, I think you’re taking in an enormous amount of risk because you’re trying to squeeze return out of a dry bone these days.
I think they have a value principally in an institutional setting for people using options, futures and derivative strategies. Say I want to go out and hedge my portfolio. Therefore I’m going to use a certain derivative strategy, but what I have is derivatives wrapped into structured products to a degree.
One example which is no longer valid because there are no interest rates in the world anymore. But I remember back in the late 1990s we were able to buy a structured product on a 1-year time frame that gave us a 130% of the upside in the Japanese equity market.
And if I were to buy an ETF, I get 99% of the index performance. If I give it to an active manager, and I get plus or minus 5 percentage points on either side of the performance. Thus we decided to use the structured product.
Obviously hidden inside there was a derivative strategy of some form. I think if they are wrapped up in a manner in which it is relatively easy to understand the payoff, it gives you a better opportunity than a delta one product.
And I think for most clients, what can they do if they thinks the market’s going down? They can sell. Well actually, there are other ways of doing this, that you can make money as the asset that you hold is falling in value. So, I hate to say structured products wrapped in a certain way even around even a private client portfolio is still a valid value.
I think it can add a lot, I’ve been an absolute believer in quant work for quite a while. I think there are certain aspects in decision-making that require you to absorb a lot of information.
For example, lets just say I have a one-dimensional model that says if the business confidence indicator in the United States goes up 5 pts, then typically 80% of the time the S&P 500 is then up in the next quarter. Why wouldn’t you use that relationship, in terms of trying to button down some of the information you look at. Thus rather than looking at the ISM survey, you say on a probability-weighted basis I know what is going to happen.
The data we’ve used in the past has been a very simplistic approach. But the adoption of AI – the adoption of real-time data in particular – is better than a 6 week old confidence indicator which is reported 2 weeks later. We can get real-time data now that can give us an insight into the market and thus give us an edge. I don’t think that’s just for the hedge funds, I think it’s for every investor. If aggregated up by good quant work, you can use that information and it’s very much added value.
It’s absolutely going to be one of the most important influences on markets going forward. Management industries are only just waking up to it. The recent changes at the European level, with these 6, 8 and 9 (which is going to be the bane of every platform’s life) say what kind of fund it is, whether it is ESG or not and a degree to which it is ESG.
Everything is going to be graded by this criteria going forward. The pension funds and endowment funds of the world, I think, are going to very simplistically say every investment that you make or manage, or every product provider, has to be compliant in some way with the standards being set.
This is going to be a very important factor. I think there is absolutely a need for a lot more true ESG product. Yet the biggest problem we have, is that we can’t even define ESG. In fact even the EU, even regulations, don’t define ESG. It is appalling what’s going on. I don’t suppose we want big government to tell us what ESG is. But we do need a shared vision of what ESG is and measure our products on, for example, an index-weighting basis in order to get to a proper conversation.
It is huge. I really do think that west of the Middle East, there is still a complete lack of understanding of the scale of what’s going on. People absorb in the last 12 months that China is big and that China will be the largest economy in the not-too-distant future. Clearly that trend accelerated last year, with its GDP growth at the time when the rest of the world was struggling.
I think the difficulty for Asia is to deepen its financial markets. We’d all like to buy Chinese GDP, but quite frankly you tell me how many funds out there can easily say that they have a proper setup to manage the bond portfolio at the moment? Or indeed even in the equity side, that they have sufficient people on the ground to really know where the opportunities are around that vast country with so much going on.
I think the other point is that we just talked about ESG. China is the biggest ESG player on the planet. It is going to be spending the equivalent of about 10 to 15 trillion dollars on cleaning its country up in the coming decades. No other country, even President Biden, is making that kind of commitment.
The best advice I can give is that you have to be completely focused. You have to run your own agenda. When you sit down at your desk: what is the most important thing that you need to do today? Make sure you do it. Often people get distracted by the markets moving in the morning or someone made this comment. If you do that, you will get distracted, you will get diluted down and you will not be as effective a member of the team as you would have hoped.
I’m only really going to mention one: which is the Big Short. The background was that I was working at Merrill Lynch through what you would say is that phase of the markets from 2007 to 09. Honestly, I think in the prior year (2006), I really couldn’t understand what was going on. I’ve been bearish and perhaps wrong. Finally, in August I saw the whole thing tip over. And I still didn’t understand why it took us another 12 months to kind of work through it.
So, I was on a flight watching the Big Short. I hadn’t seen it before and I was screaming at the back of the seat in front of me. It was just starting to be revealed to me what had been going on. I was appalled to see the behaviours of the gods of our industry at that time, the very weak individuals that created these kinds of situations and the huge fraud that occured. For me, that was the most shocking film I ever saw. I was actually quite emotional after watching that film.
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