As we are about to enter the last quarter of 2012, portfolio managers will have their minds focused on keeping the returns achieved so far on a steady and safe path. Given the performance of the investment markets so far this year, outperforming the respective benchmarks would not have been an easy task and maintaining this relative outperformance would be at the top of the respective agendas.
Passive long-term investment strategies may not yield the necessary risk-adjusted investment returns- Karl Micallef
However, the next three months will be behind us very quickly and a new challenge will commence with the start of a new year. Therefore, it is no surprise that portfolio managers are fast-forwarding their thinking by at least three months and assessing the various possible tactical strategies which will outperform the markets during 2013.
With the European crisis still looming in the background, it would be no surprise if next year is once again hijacked with uncertainty and volatility. The peripheral European countries still have a lot of work and targets to achieve; suffice to say that most of these countries struggle to achieve a budget surplus let alone reduce the overall debt burden.
Greece requires more time to achieve the financial targets imposed on it, France is trying to detract any negative attention from the market, while Spain and Italy tick along on a day-to-day basis.
Such a backdrop makes for interesting portfolio management, but the real challenge kicks in when the investment mandate is to achieve positive real returns (in the form of interest income) combined with a conservative risk profile. This is when a portfolio manager starts to think about the next financial year three months before the existing one is over.
The traditional definition of ‘long-term investment strategy’ is passé and less meaningful – today’s reality is one where ‘safe’ has a very different meaning and hence one must evaluate the investment strategy much more frequently within the long-term investment objective of any given portfolio. High quality investment grade bonds which would typically populate a conservative fixed income portfolio will yield circa two to three per cent per annum (assuming that the average maturity is approximately eight years) which in real terms is nil.
With inflation currently averaging at the same level, a buy and hold long-term investment strategy will potentially only generate enough returns to maintain today’s purchasing power of the capital invested. One may be tempted to buy longer dated bonds. #One may not have an option but to buy longer dated bonds, although we would always recommend greater caution when choosing to adopt this strategy as duration risk is one which investors find very difficult to comprehend correctly.
Furthermore, risk measurement can no longer be entirely associated with the traditional metrics. It is not enough to look at duration, ratings, asset class and currency. Portfolio management needs to go beyond that.
Investment managers need to look at the underlying security of the invested instruments, while carefully analysing the financials and operational outlook of a company on a case by case basis to ensure that the target investment return is adequate to justify the capital tied up to that investment.
This is today’s reality. Interest rates in Europe are at an all-time low and sovereign paper, which has traditionally been viewed as low risk paper, is no longer a safe haven. The investment landscape has changed immensely in a relatively short period of time – change which requires all parties in the investment world to quickly adapt to if they want to stay ahead of the game.
Even the regulators need to be aware and keep abreast of the current investment backdrop in order to fully comprehend the reasons behind certain specific investment exposures both in terms of asset class as well as underlying non-euro currency exposures. Portfolio structures have to respond to this reality, while aiming to achieve the best return possible for a given level of risk.
Today we are at a point where even the long dated, lower rated, investment grade bonds are yielding very little and hence one really needs to start actively managing the respective investment portfolios. The reality is that passive long-term investment strategies may not yield the necessary risk-adjusted investment returns.
Curmi & Partners Ltd are members of the Malta Stock Exchange and licensed by the MFSA to conduct investment services business. This article is the author’s objective and independent opinion. It is based on public information and should not be viewed as investment advice in any manner. The value of investments may fall as well as rise and past performance is no guarantee of future performance.
Mr Micallef is an executive director at Curmi and Partners Ltd.