Narach Investment

INVESTMENT WORLD AND REFLECTIONS FOR THE INVESTMENT MANAGER


With the recent advances in investment theory and practice, we have seen the advent of new products, strategies and investment assets. The main focus is on quantitative theory and practice, where most of the progress has been made, and this progress is expected to continue.

What is quantitative investment management? It is more a matter of process, in which the quantitative investment manager lets the computer do most of the work, in finding investments that have certain target characteristics. For instance, in equity management, the process imposes discipline on the security selection process. A quantitatively derived portfolio would not fail to match the portfolio characteristics intended.

Quantitative investment management per se does not guarantee success. Bad discipline quantitatively implemented would result in bad portfolio performance. There is no basis to believe that the quantitative approach is superior to the qualitative process, per se.

As more investment managers adopt the quantitative investment management process, a historically effective discipline would not be enough. The investment manager would require a disciplined process that is superior to other investment approaches including the quantitative one. There lies today's challenge, it is not enough to be different but to be better different.

Over the years the role of the sponsor/owner has also undergone a change. In the 1950s they preferred the role of the passive outsider. In the 1960s, there was growing interest, due to a growing asset base. In the 1970s, there was a building of management staff, increased importance of performance, vast unfunded liabilities, complex choices and a growing awareness of the asset/liability mismatch. In the 1980s, there was a crisis of complexity, too many choices and too few tools to work at the choices. In the 1990s, there was a clear perspective of the asset/liability mismatch and there was use of tools to control the aggregate character of portfolio plans.

Alongside there was also an evolution in the role and functioning of the fund manager. In the 1950s, the manager was a bond manager with a role to act as a buffer between the sponsor and the uncertainties of the capital markets. In the 1960s, the sponsors/owners themselves became interested in stocks and the balanced manager came into existence. In the 1970s, there was a growing dissatisfaction with the balanced portfolio and the index funds came into existence. There was this specialized manager hawking specialized products and an emergence of passive management. Further there was growing interest in covariance assets independent of the capital markets, like real estate, overseas investments, venture capital, art, rare coins, etc. Thus reducing the portfolio risk without reducing the expected return. In fact in this case the investor finds the return increased at any given level of risk. In the 1980s, there was a glut of choices in product forms, management style and strategies. In the 1990s, tools for sponsors were available. Active or passive portfolios, rebalancing, asset allocation, amongst others.

Similarly, investment theory also moved ahead in new areas. In the 1950s, there was a general awareness of the linkage between risk and reward. In the 1960s, there was the emergence of theories like CAPM and the Dividend Discount Model. At this point theory was not backed with money, the models were mainly academic. In the 1970s, the theory of the 1960s gained currency and acceptance and managers began using these tools. In the 1980s, the managers were faced with many choices. Unfortunately the tools were not available as yet to control these portfolios under management.

Quantitative theory also evolved over the years. In the 1950s, there was none. In the 1960s, came the beta, alpha, Dividend Discount Model, etc as theory. In the 1970s, the theory was applied. In the 1980s, we had the multivariate issue selection, multivariate risk measurement, reshaping return distribution, portfolio insurance, asset allocation disciplines, etc. In the 1990s, we saw the unified pricing model, long term model, short term model, etc.

Today, we have bond managers, stock managers, international managers, alternative and synthetic asset managers, venture capital managers, real estate managers, etc. Further, there has been a rapid increase in sophistication of quantitative theory and a shortening of time between development and application of theory into practice.

Today complexity breeds opportunity for those who have the staff and the time to explore these opportunities. The owner of assets typically do not have the time to explore these opportunities. So, the owner has to choose multiple specialty managers who are more capable to explore these opportunities. In the end what control does the owner have over his portfolio? The more an owner employs these new disciplines, tools and strategies, the less control he has over the aggregate portfolio.

In the present era the direction is clear. The owner of portfolio assets would move towards a deeper understanding of the nature of the asset/liability mismatch. And would have access to tools to control the aggregate risk character of the total portfolio plan. The investment managers would turn their attention towards developing products that can exploit a complex world by helping the asset owners to bring the complexities under control. The question still remains whether the investment manager would respond to these client/owner needs.

In India, we have seen in recent years a pro-active regulator in SEBI. Which is effectively monitoring and supervising the smooth functioning of the equity markets. A V-sat linked computerized trading platform. Which has reduced brokerage and other charges. And large sums of money being invested in the equity markets over the past few years by both domestic and foreign financial institutions.

All this is very good. However, we have also seen in the past the sad, unexpected and unprofitable performance of mutual funds. Most of them traded below their issue NAVs in the past.

This directly points, to a requirement of educated, qualified and experienced investment managers. In today's investment environment, it is not enough to be good, but to be better good. Further, the asset owners and clients would be more demanding, and in all probability would be looking for better than average performance from their investments.