In its second annual think tank involving family offices, high net worth investors and their specialist advisors, Brookvine dissected the value of diversification. The differences between these investors and big super funds are fascinating. The super funds are not always right.
Steven Hall, managing director of Brookvine, a fund manager and distribution firm, said the recent workshop with private wealth investors and advisors, followed a similar gathering the year before whereby the “principles, models and beliefs of institutional investing were challenged”. The private wealth managers discussed the extent to which common institutional practices should or should not apply to them.
In the latest workshop, which Brookvine has called ‘Whiteboarding 2.0’, the firm drilled down to the specific topic of diversification, to establish differences between how super funds and private wealth investors and advisors felt about the topic – the foundation of Modern Portfolio Theory as espoused by Markowitz in the 1950s and still regarded as doctrine today.
Hall said, for instance, institutional investors often favoured highly diversified (low conviction), long-only portfolios that closely mimic equity and bond market indices.
“Some HNW/FOs on the other hand are biased towards less diversified (high conviction) portfolios but may also include greater exposure to absolute-return oriented funds and niches in mainstream markets that offer better diversification to broad-based indices.”
In a report summarising the workshop Brookvine says: “The limited inclusion of hedged equity and bond strategies by most institutional investors is a real limitation to their diversity. These strategies accommodate shorting, (albeit with a net long position) and dynamically adjust their exposures to the market.
“Participants agreed with institutional investors that the tools of diversification apply across asset classes and across investment approaches provided the focus is on intrinsic investment characteristics and strategy, not merely on ‘style-labels’ such as value and growth.
“There was little discussion on diversification across risk factors, a topic that dominates institutional thinking if not practice. This was not surprising given the lack of agreement on what constitutes a risk factor and the difficulty of modelling the often-idiosyncratic risks in private wealth portfolios.
“Yet participants were concerned that, even in conventional ‘70/30’ portfolios despite being diversified across international, domestic and emerging equities, real-estate, bonds and credit, around 90% of portfolio risk remains equity risk.
“Strong comments were made on the risk of over- diversifying (‘diworsifying’), consistent with Charlie Munger’s [Warren Buffett’s deputy at Berkshire Hathaway] admonition, a common result of advisors and other agents (subliminally?) minimising career and business risk.
Agency issues led to the query: are there material differences between diversification in advisors’ personal accounts (PA) and those of their clients? The consensus was that often there are differences that can be justified by different objectives, liquidity needs and risk tolerances. One participant claimed that “most” investment professionals under-diversify their PAs on the grounds that “it’s my money so I can have more of a punt.”
“Whether diversification is the oft-touted free lunch led to vigorous discussion. Participants saw the main ‘cost’ as the added complexity of more asset classes, demanding more advisor time, thus making fees an issue.
“Related to cost was an engaging debate about the perceived failure of diversification. This was seen as a consequence of economic and portfolio globalisation and of post-crisis central bank policies. High correlations between asset classes make diversification less attractive, except perhaps for very long-term investors. This view is re-enforced by the one-way path in asset prices clients have experienced for almost a generation.
“There was some agreement that a more dynamic approach to diversification is now needed to replace the more common quasi-static approach. This suggested to some advisors to HNW clients that the pricing models for services needed to be scaled to accommodate different levels of value add.”
* Greg Bright is publisher of Investor Strategy News (Australia)