Video Steadying the ship webinar

00:08 
Hello and welcome to this presentation on Steadying the Ship, where Anthony McDonald, our Head of Portfolio Management, and I are going to have a chat around risk managed portfolios and how to use them in times of market volatility.

00:25 
You will see here that we have associated with this presentation four learning objectives. And I will let you read them at your own pace. And I will dive right into the conversation if that's okay.

00:41 
Bringing in Anthony McDonald, our Head of Portfolio management. Anthony, how are you today?

00:48 
Hello, Tom. Yeah. I'm good. Thanks. Thanks for having me. How are you? Great, it's great to have you. Yeah, thank you. 

01:00 
Anthony, do you want to tell us a bit about yourself and what it is you do?

01:01 
Sure. Of course. Yeah. As you said in the introduction there, I'm the head of portfolio management here, Aegon UK. That means I lead a team that manages a wide range of multi-asset solutions across the business, using our research and our portfolio construction expertise to build portfolios that deliver good investment outcomes for investors.

01:21 
Well thank you, Tom. Maybe a quick introduction to yourself.

01:23 
Yeah, sure. So thank you. I'm Tom. I head up a small team of behavioural researchers and customer researchers at Aegon. 

So, really, what we do is we explore why it is so hard for people to make good long-term decisions for themselves. And what that means in terms of investment strategies and how we can help them make better long-term decisions. And in essence, that is really it. 

01:49 
It sounds as though we are perhaps from different planets. But in the same organization, obviously, and perhaps very much still in the very same orbit. So let's see. Perhaps that's how we start.

02:03 
Can you tell us a little bit, Anthony, about the objective of risk managed portfolios and why you see increasing demand for them?

02:16 
Yeah, sure. So and actually, it's interesting you should talk about kind of different orbits and similarities because one of the things we always have done in building and implementing our processes is thinking about behavioural risks and trying to minimize them in the way we go about things. Because actually what we're trying to achieve in a nutshell is to offer simple and cheap investment solutions for investors.

02:38 
We've built a range of multi-asset funds here that get broad exposure to stocks and bonds, mixed together in different weights according to their risk level. And what we're finding is that solutions like these, particularly because their funds run the model portfolios, and then the capital gains tax world, forming part of adviser centralized investment propositions. They're simple, they're cheap, they're reliable. And that can allow investors to use them with confidence within the broader financial planning piece.

03:06 
Yeah. Okay. Right. If we come to you about, I suppose, you see a shift in trends in financial advice as well, don't you?

03:13 
Yeah. And in fact, you know, it's a shift that is very much facilitated by solutions that are coming out of your world when we're seeing that perhaps the sort of classic alpha type value proposition of a financial adviser is increasingly being challenged.

03:28 
So, you know, classic alpha, that is, of course, you know, it's all about performance of the policy portfolio versus the benchmark portfolios, about asset allocation. It's about costs, etc., those types of things. And we see this being increasingly challenged and the industry moving away from that in favour of a more sort of life planning, perhaps focused, type of advice, where the adviser is focusing on how the investment strategy is actually useful so as to achieve life goals or bigger objectives on behalf of the client.

04:04 
I think there's perhaps another reason that is driving that. So one is, you know, you mentioned that these automated solutions or outsourced solutions are a way to minimize costs and to simplify. And that is, of course, in the interest of every business. But I think that's perhaps also a bit of a recognition in the industry, increasingly, that clients are not really interested in portfolio construction. It's not really what excites them. And it's perhaps not really the reason why they are seeking financial advice in the first place.

04:38 
I mean, yeah, absolutely. They buy an expertise and they buy certain functional and technical knowledge when they buy financial advice. But really what they're interested in is achieving certain goals and certain life goals. They want to make sure that they can live the lives they want with the resources that they have. And that I think is increasingly the world of financial advisers operating in.

05:02 
And of course, to do that, it's not, you know, the investment strategy and the financial side of it is one important part of it. But another very important part of all this is understanding, well, what is it that the client actually wants? What are those life goals? What are those long-term objectives? What are those values? What is it that the client wants to achieve with the money?

05:22 
So you have another type of conversation as a result, rather than a sort of technical and functional type of conversation, one that is much more concentrated on the human side. So and in fact, I can perhaps bring this up very quick, this page here. So this is the key word that I'm speaking to, increasingly, human-centric advice.

05:48 
So, and you can pause the video here very quick if you wanted to look at the different dimensions, product-centric versus client-centric versus human-centric. But I think this is really where we are seeing ourselves, that we are increasingly in the human-centric world, delivering a human-centric type of advice rather than a product-centric or client-centric world.

06:10 
Well, perhaps back to you, Anthony. Let's look at your risk-managed portfolios again. And, it's in the name, isn't it? But risk is being managed. What does that mean though? And in times of market volatility, I mean it's inevitable that markets will fall or are going to enter sort of correction territory one day and sooner or later there will be a "this is the end of the world" type debate.

06:37 
So how do your risk-managed portfolios come in? And how do you think about these in times of market volatility?

06:48 
Yeah. There's lots of different layers to that. I'd say deliberately to start off with. I think if I kind of summarize that up in a nutshell at the start, the biggest single answer I could give is we don't panic. Mostly because we think that leads to bad decisions and we trust in our process, which is exactly there to stop us making kneejerk mistakes and those bad decisions.

07:09 
So if I unpeel what those different elements are that we think puts us in good stead to make good decisions around before and after kind of difficult market conditions, kind of losses, sudden volatility. 

The first layer I point to is broad diversification. You know, I think a lot of people listening to us when they've seen the typical kind of what I call a patchwork quilt chart, that just shows that variability in the performance right here. Different assets from year to year. You know, sometimes maybe the US equities might be the top, sometimes commodities might be top, sometimes bonds might be at the bottom or the top. You know, it looks like a kind of random walk. 

07:48 
If you put a lot of these kind of decades against each other. And what we're trying to build and offer here are broad multi-asset solutions. And the core philosophy that our starting point is to offer exposure across a range of those individual investments. You know, on any given year or short term, there are lots of different factors, some maybe white swan, some maybe black swans, kind of more or less predictable, that can change performance patterns.

08:18 
And while over the long-term we think that we can make decisions to add value, we're humble over the fact that short term noise can occur, can be unexpected. And that by having that broad diversification as a starting point, the funds and hence the investors should be in a position to help avoid extremes of performance, both up and down.

08:40 
So there's the kind of product diversification which acts as a starting point. Underneath that, we think strategically, as I touched on a little bit there, about how we navigate positions over time. The mindset there is steering a little away from less attractive investments and towards more attractive ones over a longer-term time frame.

09:00 
So, talking about the vagaries of short-term market moves, we're not talking in any way about day-to-day trading. We actually think ranges are kind of longer-term approach in philosophy, and they really discipline about being true to that. But often thinking about measures of value compared to history.

09:20 
We do think about how much we're paying for different investments. Think about those that may look particularly cheap or particularly expensive versus history. And if and when there are those opportunities where we think that valuation versus history seems unjustified, then we'll tilt the portfolios accordingly using that kind of long-term view of risk and reward.

09:42 
And the way that links back to the original question on volatility and losses is we do think that cheap investments, essentially trying very hard not to overpay for things, can lead to a better margin of safety, kind of less space to fall in difficult conditions. You know, not necessarily bucking a broader market trend, but when you think about how much different investments may offer better protection at times, we think that that's a broader approach that can be helpful.

10:10 
If and when we enter those more difficult market conditions, of course.

10:18 
And I now know it's interesting you say when it occurs. So, because as you guys say, it's not if but when. So, we kind of assume that it will one day happen. So can I just ask then, more specifically, is that a sort of set of rules that you apply? Sort of like if, when, then scenarios. Is that how it works?

10:44 
Yeah, but not quite like that. But we think it's important to understand that there is normally a reason why markets are falling. I take Covid as a good example. Right. The world suddenly stopped. And so in a very short time period, equity markets fell a very long way.

11:07 
And if when then kind of set a set of rules would have been, and probably for a year or two after Covid, this would have been completely kind of set up by the fact that that was something that hasn't happened before in living memory. And so the amount that things fall in kind of effectively what that underlying fair value is, that you're assessing whether things are expensive or cheap against is dependent. Also uncertainty amongst the is dependent on circumstances.

11:36 
But what you do touch on is still a pretty important starting point, which is there is a broader framework that we think about, which means when investments, different markets look to be getting a lot cheaper, that means we get interested because, you know, if we think about ourselves as trying to take a long-term value approach and steering investors' exposure within risk profiles towards investments that end up cheaper as markets fall, they start to look cheaper where the if when then falls.

12:06 
That is we have to think about whether the underlying fabric is falling as well, such that you're not necessarily getting overreactions. But what we're always looking at are questions within the team. Our analysis is always focused on that condition, on whether and when different markets are looking more compelling on a long-term view, bearing in mind the kind of fundamental risks and opportunities in that market and where the pricing has moved to.

12:29 
And that's a little bit of luck that will dictate whether or not we do. But we're never trying to catch an absolute bottom in markets or turning points, or to sell things at an absolute top. There are two reasons for that, really.

12:49 
Ultimately, we think that's more about luck than judgment. Because that in itself comes to our starting philosophy that markets can overshoot fair value, they can get expensive in the first place. They can undershoot fair value, they can get cheap in the first place. As soon as you're at extremes of that and you're unanchored from the concept of long-term value that the price is referencing, then it's very difficult if not impossible to know exactly when it's going to stop.

13:19 
But what you do know is if things are getting more and more expensive on our models, our indicators, then the risk of having a more difficult period is higher. And if they're getting cheaper and cheaper, the risk of them then falling with a better period is higher. So what you'd expect is as investments get more expensive over time or fall and get cheaper over time, we would be gradually increasing our positions when we felt that there was real long-term value emerging.

13:51 
And actually, if we were trying to stop and think, when is it going to stop, is it going to go up? I think that would hold us back from gradually adding new positions when they made sense for the funds. And ultimately, if the underlying investors would actually risk us falling into the trap that we're trying to avoid, which is using the fear of others to gradually take risk in the funds when it's well priced.

14:16 
That often does come with market issues and market losses. And we try to, at those times, look forward to the opportunity rather than being too anchored to what's happened in markets before then, which I suppose is probably I could link across to you because you're a behavioural researcher, you have views on market volatility, behaviour patterns around that, and what maybe advice could do in such times.

14:41 
Yeah. Yeah, absolutely. I mean, market volatility is of course a subject area that has been studied by behavioural finance experts for a long time. And I guess, you know, what we would typically have done, I say we as in the behavioural finance community, what we would have typically done is we would have sought to identify all sorts of biases and fallacies and thinking errors, thought errors in retail investors, but I daresay also professional investors.

15:11 
So the sort of biases that we would have identified are things like recency bias where we pay, perhaps, one-sided attention to what is happening here and now, rather than bearing in mind a long-term picture. So this is very much what you are speaking to when you're saying, well, we've got to be really disciplined. We've got to have a long-term mindset, etc. So not to be distracted too much by the noise, what is happening here now.

15:36 
To overcome that recency bias, then of course there's things like action bias. Right. So when things are tough and it's not really something that is in our control, then many people feel like I want to do something. So that you get this sense of control. And action bias is how the behavioural finance community would describe that.

15:56 
Another example is confirmation bias, where you're running around and you're just seeing information that just confirms preexisting beliefs or thoughts already. So these are just three examples of biases that the behavioural finance community would identify in times of market volatility.

16:20 
I think perhaps more recently the behavioural finance experts are taking not a step back, but they're a little more reflective. I think oftentimes where this is coming from, we had for a long time this sort of standard economic view that people are rational decision makers and present them with a choice.

16:37 
And, you know, they will select the option that makes most sense, considering what their goals are. And of course, the behavioural finance community stepped in to say, well, no, actually, that's not how it works. We are not those rational decision makers. Rather, we are irrational. And they needed to make the point.

17:00 
Rather, we are irrational. And I think what is happening increasingly is that this label of irrational is being, not questioned, but it's qualified a little bit. And that we are beginning to highlight really where this is coming from and that's under very specific circumstances. It's actually totally understandable why you would feel in a certain way.

17:22 
I mean, in times of market volatility, picture a client who's perhaps about to retire, they're feeling comfortable because they have a certain amount of savings that, according to their financial adviser, will suffice for a comfortable lifestyle in retirement. Now the markets tank. It is totally understandable why you would feel anxious and fearful. Why? Perhaps you would also feel regret or shame or all sorts of things.

17:53 
And I think this is increasingly being recognized. So what I guess is happening here is there's much more empathy. So rather than being quick to say, this is irrational and this isn't right, much more like, well, we need to take a moment to understand why that is coming from and then work with that emotion. I think what advisers can do then is acknowledge that.

18:22 
So, you know, have to show that empathy, that it is understandable that under certain circumstances you feel that way. But really, what is important is to redirect attention to what matters. And what matters, of course, is the long-term goals, the long-term objectives. You know, what was it actually that you set out to do when you built that financial plan? Yes, markets may have tanked by 10% or may have fallen by 10%, but progress against your objectives probably hasn't decreased by 10%.

18:45 
So you kind of shift in favour of a personal benchmark to use a word from Doctor Daniel Crosby in his book, when he talked about personal benchmarks. I really like it, by the way. In the English language, you say you pay attention, right? Because what that highlights is that attention is a scarce good right now. We've got to be economic with it.

19:09 
So we cannot, by definition, pay attention to one thing and pay attention to another thing at the same time. So I can't go out with my partner for a meal and answer emails at the same time. Well, I can't play monopoly with the kids and listen to music at the same time. So to pay attention to one thing inevitably means I'm not paying attention to the other thing.

19:31 
And I think in this context, what we've got to be mindful of is that in times of market volatility, there is a lot of noise that is seeking, grabbing, or attracting our attention. To like, you know what, look at this in the news and look at this expert who is offering this interpretation of what's happening. Or here's another expert who's telling us why this has never happened before and why this is a really unique circumstance.

19:57 
And this is, of course, really hard not to pay attention to. So what advisers, what the good advisers will be doing is to redirect attention from what is happening here in the news, in the noise, to the long-term plan. Really encourage and educate the client to pay attention to what matters.

20:32 
Well, yes, essentially you should say that, because one thing I do sometimes, exactly. Because the noise and actually, hey, if I step back, we deliberately embrace noise in some parts of our process because it can help us identify, understand changing trends or challenges to diffuse and positioning in the funds.

20:56 
But there are other parts of our process, the core of it really, where we try very hard to filter out all the noise because, you know, one of the ways investing has changed over decades is information went from being a scarce resource where if you could get more information, you had an edge to it. And it's still very important if you get the right information. But there is lots of information and data and economic data that comes out, and it's publicly available every day.

21:28 
And we think that people, investors, and even some fund managers without a process for passing that can end up being pushed around by that data. And so we start off by saying these are the things that matter to the core of our process. Unsurprisingly, from what I've said before, valuation metrics are part of that, but not all of that. And we regularly reorient ourselves on those points as the core data points that we think matter for specific reasons.

21:58 
And that's that part where we try to filter out the noise and focus on what we think is the important long-term signal. And one thing I try to do from time to time is I sit down sometimes. And it doesn't have to be the time of volatility. I write down, however many, normally 5 to 10, the key things that are dominating the newswires and the discussions and narratives in markets at any point in time.

22:18 
And I go back to that six months and 12 months later, and you'd be surprised how few of them, maybe you wouldn't be from what you just said, but it's always interesting how few of them have an enduring impact on either the psyche and the analysis or actually the market outcomes themselves. And so it's always a good reminder, whenever we will do anything to step back and say, we think about probability and significance. And that's always a good starting point.

22:45 
Yeah. So yeah, I think, you know what, as you were speaking, I was thinking there's perhaps something that advisers can apply in relationships with clients as well. Obviously, what becomes very clear in the way you present how you guys have thought about this, how you guys have thought about market volatility and what it means and what we do when certain things happen, etc.

23:09 
But really, the acknowledgment to the appreciation that bad events will happen, and you are prepared for them. And I think perhaps what advisers could do is when times are good, they could speak to their clients and prepare for those scenarios as well. They can say, well, you know, it's inevitable that these periods probably are going to happen. I don't know, we don't know when, perhaps in two years, perhaps in five years, perhaps it's around the corner. We don't know.

23:36 
But what is really important is that when these things happen, we remain calm and we pay attention. We keep our eyes focused on the long-term goals, etc., perhaps similar to what you're doing so that in the event or when the market volatility does occur, the adviser can say, remember we talked about this and we said, you know, when this happens then we will remain calm and we will pay attention to the long-term focus, to the long-term goals.

24:06 
So it's perhaps, you know, on a micro level, what an adviser could do when applying your thinking. Yeah, I think so.

24:18 
So should I bring it to life a little bit and. Yeah. Yeah, yeah. The most recent significant bout of market turmoil was 2022, when we had the interest rate response to the post-Covid surge in inflation. And, you know, thinking about our approach to some degree during that period, I suspect brings to life some of the things I was thinking of before in terms of not panicking, staying true to our process, thinking about our valuation judgments, and putting it all together to make considered analytical decisions that we think are in our investors’ best long-term interests.

25:04 
And, you know, our starting point over 2021, as it happened, was the rock bottom bond yields seemed to be underestimating the risk of inflation. And the central bank response to inflation because we were seeing those inflation numbers picking up from the first half of 2021. And of course, the central bank messaging was that it was transitory.

25:31 
And so it did seem to us that there was a higher risk than at other times, of falls in bond markets. Of course, that might not materialize. There are always many different paths that things can take. And so, you know, as I said, within the context of a diversified portfolio that did lead us to be more careful on the bond weighting in the portfolios.

26:01 
But then when we got to late December 2021 into 2022, that was when there seemed to be that broad realization that the inflation risk was less transitory. We saw Jay Powell, the chair of the Federal Reserve, talking about that in the fourth quarter of 2021 and retiring the word transitory. And it was really from then into 2022 that we saw that very sharp uptick in bond yields, as markets repriced their expectations for interest rates from them staying very low for a long time.

26:29 
And you like to your anchoring world, that was the world that many wouldn't have been used to for most of the post-global financial crisis period. So a sudden acknowledgment that interest rates would have to go up to try to contain the inflation problem that had emerged.

26:45 
And in that period, having started with clearly I said these funds target certain risk levels and they do try to mix bonds and equities together. So they clearly had some of each. And it's always difficult when funds lose money in absolute terms even if they're outperforming.

27:09 
But throughout that period it was a continuing and ongoing continual focus for us on how significant is the ongoing inflation threat, how high do we think bond yields are going to have to go to effectively stamp out any kind of long-term price pressures in the system, and then you start thinking about what if expectations and the way they feed back through to inflation as well, and therefore as bonds are getting cheaper because their prices are falling

27:31 

What stage does that mean that they stop being a long-term kind of risk and start going on the side of long-term return potential instead?

27:51 
Yeah. And as you'd expect, the first move, we don't necessarily do very much because over the long-term small moves don't necessarily have a very big impact. And there's always the same actions, zoom back from the short term moves and show how unusual it is for kind of five, ten, 15% falls in any markets to have an impact on the long-term price return shocks.

28:19 
But if we zoom back from those short term moves and think about what level do they start getting interesting? And then we start to gradually scale into bonds when they reach those levels. And then when they get very interesting, because we think those yields are attractive in terms of representing a long-term return potential, maybe start looking too cheap for us in the context of the underlying economic fundamentals. Then you would see us establishing a larger position.

28:44 
Right. Yeah. I mean, I guess we want to come to a close, slowly but surely. But it really sounds as though the risk managed funds are a great way to free up the adviser's time to do what really matters. Is that how you would perhaps circumscribe it?

29:05 
Yeah, that's exactly what we aim to do. So the set up to be deliberately simple, deliberately cheap, and offer exposure to a range of equity and bond sectors such as that, that they provide a diversified investment for a client where the adviser can hopefully be comfortable that they will do what they say on the tin, they will be appropriate for that client's risk level according to the adviser's own analysis, and that the outcomes ultimately, to your point, will not be a surprise to the adviser or to the investor.

29:41 
And of course, the aim there is to deliver the investment outcomes that are in keeping with expectations, which should hopefully be able to free the adviser up to take a broader picture of clients. And I suppose you're in a position to tell us a bit more about what we're freeing the adviser up to do.

30:00 
Yeah, absolutely. So I mean, I suppose, you know, if that is all taken away from them, then that really would give them the time to get to know their clients, to get to know them at a deeper level, to ask good questions. We have more educational material already here, also on the CPD hub, on what kind of questions to ask and what skills to apply so as to learn what really matters to the client.

30:28 
Perhaps the one thing, as a rule of thumb, that would be really useful to use the time they now have is to work out what is the long-term vision of their future self. Not only the client themself, but also the unit, they're thinking of the family typically. So what does it mean? What is their long-term goal? Where do they want to live? What do they want to do day in, day out? Who do they want to spend time with? Will they have a dog? All those questions filled out with meaning, like, build a long-term vision in terms of what it is that the client wants to achieve.

31:08 
And yeah, that, I think is something that perhaps in the past, advisers didn't have that much time and bandwidth for, but if they're freed up, if some of the, you know, in the past, more typical tasks are becoming automated or outsourced, and that is really something that the adviser can do. So as to deliver a much more human centric or client centric, whatever you want to call it, type of financial advice.

31:33 
Perfect. Great. I mean, this has been a very good conversation. Really enjoyed it. So. We’re, yeah, I still obviously from different planets. But yeah, very much in the same orbit, I would say, in terms of what we're seeking to achieve, just that the means of how we're doing it are perhaps different.

31:57 
So, thank you very much for your time, Anthony. And thank you very much for listening. I hope you found that useful.