Wealth Strategies

Getting Into The Details Of Investment – In Conversation With Partners Capital

Tom Burroughes Group Editor 3 October 2024

Getting Into The Details Of Investment – In Conversation With Partners Capital

This publication talks to an international investment house about the future of the "60/40" equity-bond portfolio split, the role of alternative assets, how to steer a course through geopolitical turbulence, and more.

Back in August, this news service spoke to Partners Capital, an outsourced chief investment office overseeing $55 billion of assets, about the importance of after-tax returns. A very important consideration today when governments could hit investors on both sides of the Atlantic with higher taxes. 

Away from the specific tax concern, however, there is much else to understand about how approaches to asset allocation and risk are evolving. We spoke to Euan Finlay (pictured), head of EMEA at the firm. This is a business that prides itself in its "endowment model" of investing – holding illquid and liquid assets to suit the time horizons of clients, often in ways that involve holding private market investments and other "alternatives."

WealthBriefing: What is your current overall approach to risk and risk assets in terms of what level of risk exposure you are prepared to take for the next six to 12 months? Please give reasons for the stance that you take.
Finlay
: Our belief is that aiming to generate long-term outperformance by varying risk level based on macroeconomic views is very challenging. Few investors get this right. Accordingly, our philosophy is to keep risk constant requiring rigorous re-balancing back to target risk metrics throughout the cycle. We believe that this discipline can consistently add outperformance over decades for our investors. Therefore, for the next six to 12 months, our overall portfolio risk level will remain in line with long-term targets, as per our investment philosophy.  

WB: In what ways have your risk approaches changed over the past one/two years, and why?
Finlay
: What changes year-to-year is the asset classes in which our portfolios invest, albeit, calibrated at the overall portfolio level to maintain constant overall risk. In the last two years, we have allocated more to credit, both publicly traded credit (particularly structured credit) and private debt (upper middle market direct lending when the opportunity was particularly attractive, but as the weight of capital has compressed spreads for larger loans, we have migrated to lower middle market, capital solutions and sectors where the supply of and demand for capital are more in our favour to the benefit of spreads and credit documentation). 

We have also increased allocations to absolute return strategies which we believe benefit from both a higher base rate and potentially a more volatile environment to their benefit.

WB: What is your approach to diversification? Is the old 60/40 equity/bond allocation split now dead or is there still traction in it, given the recent rises in the risk-free rate as central banks have raised rates?
Finlay:
The 60/40 equity bond portfolio relies on the correlation benefit between equities and government bonds. With the re-emergence of inflation, which we believe will be biased upwards in the years to come, that correlation is less reliable. Accordingly, we diversify across many more asset classes including absolute return, property, highly collateralised lending and truly uncorrelated strategies such as litigation funding and royalties. Whilst government bonds clearly play a role in multi-asset class portfolios, we would not rely on them to the extent of the “40.”  

WB: How large a part of your approach to diversification and risk is taken up by private markets, hedge funds, commodities and real estate? How do you execute these ideas – do you go for funds, listed alternatives, exchange-traded funds, others? What are the costs and risks of such approaches? How do you try to ensure portfolios aren't overly complex?
Finlay: Very significant. “Alternatives” broadly defined can be 60 to 70 per cent of our portfolios (although we do not invest in commodities). We are believers in private equity and expect that it will continue to outperform public markets due to a combination of our belief that private ownership is a better governance model and the operational value that private market managers can bring to portfolio companies. 

We expect outperformance will be in the middle market, those managers that have operational improvement capabilities and, in those portfolios, where investors can co-invest alongside managers to reduce total fees. We invest in third-party managers and co-invest alongside them. This is facilitated by decades of investing in these asset classes resulting in high quality sourcing plus improved decision-making, very substantial teams situated globally to cover local markets, technical expertise in assessing managers and transactions, dedicated co-investment teams to source and move quickly thereafter, and the requisite scale to drive improved terms.

We also invest in hedge funds, predominately absolute return (those strategies with minimal directional correlation to traditional asset classes). Judiciously constructed, these portfolios can generate 3 to 5 per cent premium over the cash rate over the long term with minimal reliance on equities and bonds. This introduces substantial uncorrelated return into portfolios to the benefit of clients, in a world where achieving true diversification is increasingly challenging.    

WB: Getting asset allocation right also requires a lot of data, and that means having the technology to enable all this to be analysed correctly and quickly. Can you discuss a bit about how you do this?
Finlay: I agree. The “table stakes” requires depth of team (data teams, tech team and investment teams) and willingness to invest in data processing capability. But we endeavour to ensure that we are sourcing data and information from differentiated sources. For example, we are invested in many of whom we believe to be the premier asset managers in their sector/niche. The information that is shared through our regular interactions with those managers (plus the other 2,500 manager interactions that we have each year) provides a highly differentiated source of real-time data/information that is difficult to replicate. Finally, no matter how high quality the data, investment performance still requires judgement executed by experienced and high-quality professionals.   

WB: What's your approach to where "direct investing" (not using a pooled fund structure) fits into a client's portfolio, if at all? Assuming a client might be an HNW or UHNW individual, do you tilt towards such ideas in particular ways?
Finlay
: Our direct investments are typically co-investments in private equity, private debt and real estate alongside our selected managers with no (or highly discounted) fees. These play a very significant role in our portfolios given the return potential (i.e. benefitting from significant fee savings in addition to the return of the underlying investments).

However, with the exceptions of our co-investment capability and passive exposures in index tracking funds which are acquired directly, our portfolios are typically invested through third-party asset managers.

We do not have in-house asset management which acquires stocks, corporate bonds, real estate etc directly; this is partly given our ethos of eradicating the inherent conflict of interest that can create and a belief that in the competition for talent, those most likely to generate outperformance through security selection are attracted to owner-operator firms with significant alignment of interest. Accordingly, to access those individuals, we invest in the funds that they manage.   

WB: How concerned should we be that alternative investments are off the table for anyone outside the HNW bracket, often because regulators won't allow people in the retail/mass affluent space to engage in them? What signs of change do you see? For example, do you think that "evergreen" structures for private equity can help unlock this problem?
Finlay: Given our investment philosophy, it would follow that we believe that the returns of portfolios would be enhanced through allocation to alternatives. However, these asset classes are complicated, often have high fees and can be illiquid. We believe that construction of portfolios within these asset classes requires large and experienced teams which are able to source attractive opportunities and the ability to perform the requisite due diligence. In short, certainly an opportunity to enhance returns but “do not try this at home.” 

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