There has always been something special about the start of a new year. Whether it be the satisfaction of a past year well done or the regretfulness of wishing you achieved more, putting keystroke to machine and making a list always brings about a renewed sense of purpose and focus. Russian psychologist, Blum Zeigarnik, describes our tendency to have nagging thoughts about unfinished tasks – research shows that making a list of these things can help free us from anxiety. This Zeigarnik effect is well documented; the oldest sets of sequential signs discovered by archaeologists were etched into rock around 3200BC.
So what is your investment to-do list for 2018? We have come to the end of another eventful year: political elections in Germany and Japan, historic US tax reform, central banks world-wide shifting to tighter monetary policy and the meteoric rise in cryptocurrencies to name a few. A cursory review of literature reveals broadly general agreement on the future: the road ahead is more challenging. This provides an unsettling backdrop for even the most optimistic of investors. To ease our collective consciousnesses we have created our own list of five key topics investors should think about in 2018.
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Sustainability and long-horizon investing
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The Future Fund and Willis Towers Watson 2017 asset owner study highlighted that while sustainability is an important emergent subject for leading asset owners, opportunities were being missed in the overlapping areas of sustainability, ESG, stewardship and long-horizon investing. Investors have to combine two drivers to build a successful sustainable strategy – investment beliefs and an understanding of their wider sustainability motives. Clear beliefs, policies and practices are critical to managing sustainability risks and thinking about long-horizon investing. Best practice models fully implement financial and extra-financial factors into portfolios while reconciling wider stakeholders and time-horizon pressures. We continue to see the pace of adoption for better sustainability practices quickening. Investors need to ‘up their game’ or get left behind. Linked to this, the old paradigm of investors managing risk and return is increasingly being extended by a third dimension which references the real-world impacts of the portfolio through the lens of the UN’s Sustainable Development Goals. The prize for investors? A stronger social licence to operate, growing trust and the expectation of long-term better risk-adjusted returns.
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Building a robust risk management framework
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While the VIX volatility index is at historic lows (indeed markets seem to be no longer surprised by the unexpected), the SKEW index suggests that investors are becoming increasingly concerned about low-probability, high-impact events (tail risk). Following a multi-decade developed market shift towards the political centre, the global financial crisis has reversed that trend and investors are likely to face heightened political uncertainty for some time. Indeed over 2018 we face elections in Russia, Italy, Mexico and Brazil, the October EU deadline for the EU/UK agreement on the Brexit deal, proxy wars between major oil suppliers, Saudi Arabia and Iran, and increasingly tense jousting between the US and North Korea. These localised risks have the potential to morph into high-impact systemic risks. The US approach on free trade and China’s aim to deleverage its economy are further disruptors to the current regime.
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A robust risk management framework is key in this changing landscape. Building a deep understanding of scenarios, extreme risks and the investment ecosystem, being adaptable and employing coping mechanisms (such as tail risk hedging strategies) is vital to survival.
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Diverstiy
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Biases in investment decision making are more numerous and deeply embedded than investors readily recognise. The subject of diversity is attracting attention at all levels of society with a particular emphasis on gender, age and background diversity. The merits of diversity and inclusion in an organisational culture follow from the values of fairness and integrity pursued by leading employers. Diversity also helps reduce group think and the value of improved diversity has now become generally accepted (indeed several funds have already started putting rhetoric into practice).
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At the Thinking Ahead Institute, we have also sought to understand the benefits of cognitive diversity on the performance of teams. The research we have considered has thrown off some practical ideas along the way to achieve this: work hard on equalising the verbal and non-verbal contribution of everybody in the room, and use the task context to guide the composition of the team. So how diverse is your investment board?
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Technology
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Human decision making has its limitations. To reduce biases, investors need to make their decisions through a combination of human input (we refer to this as ‘social technology’) and systems/support (we refer to this as ‘physical technology’). Recent research by the Thinking Ahead Institute on The Asset Owner of Tomorrow notes that the slow speed of change in social technologies (think committees) is being overtaken by the fast speed of change of physical technologies (think automation). Achieving balance and efficiency between these will require considerable effort and skill in the coming years.
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There are a number of new applications of technology that support better decision making, notably new platforms, new asset allocation processes, AI applications, machine learning and blockchain applications . We are also beginning to see an overall shift from products to platforms (where customised solutions are built from products); and from traditional core institutions to crowd-sourced versions (where peer-to-peer structures disintermediate). While the need for human judgement remains critical due to the complexity of data, leading investors must upgrade their technology to be competitive.
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Purpose and culture
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The CFA study, Future State of the Investment Profession, describes the scenario of ‘purposeful capitalism’ where the investment industry raises its game with more professional, ethical, and client-centric organisations. While the ongoing debate on the role of the investment industry is unlikely to be settled in 2018, there is growing consensus that ‘the fundamental purpose of finance is to contribute to society through increases in societal wealth and well-being’ (CFA). Pitt-Watson and Mann in their recent paper also note, ‘a productive finance industry is one which fulfils its purpose effectively and efficiently, bringing benefits to all its customers and supporting economic growth’.
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Purpose, trust and value are all connected. We believe that the financial services industry will only thrive if end users have trust in the system and obtain fair and sustainable results from the services and actions of its agents. There is an increasing need for T-shaped investment professionals (that is, those with both breadth and depth), who are machine friendly, adaptable, and have the technical skillset to navigate our industry’s complexities. Additionally, investment organisations are increasingly differentiating themselves by referencing their values and culture. Culture is inextricably linked to (1) the purpose and drive of the organisation, particularly in its passion for serving and (2) the people ethos – how the team is treated and behaves. Asset owners should first and foremost attend to their own culture. Collaborating with organisations whose culture and values are aligned should also become an important part of an organisation’s cultural plan.
So that’s our list for the new year. Hopefully it will serve you well and we welcome any thoughts on your organisation’s key priorities in 2018.