Last week I attended the Portfolio Construction Forum in Sydney. It was a two day conference where a range of expert speakers such as fund managers, economists, analysts and academics, spoke on how advisers can future proof a portfolio and what they can expect in the coming years.

Here are the notes I took.

The concept of future-proofing is the process of anticipating the future and developing methods of minimising the effects of shocks and stresses of future events.

PIMCO – Marc P Seidner CIO – Non-traditional Strategies, a managing director and head of portfolio management in the New York office.

  • 70% probability of a global recession in the next 3-5 years.
  • Past performance is not an indication of future performance.
  • Future proofing shouldn’t be a question but an exclamation mark.
  • 10 years are coming up on GFC.
  • QE is now QT – and the tide is going out.
  • ECB will be raising rates by next year.
  • Unemployment and budget deficit are inverse 2018, but have always been correlated.
  • Value based investor – but the 3-5 years have been a momentum based market and passive are the arch enemy of active and value.
  • Rude awakening.

Finology – Why we get it wrong – culture not companies dictate trends. Tassos Stassopoulos – CIO Trinetra Inv Management.

  • Culture not companies dictates trends.
  • Benchmarks point to past and is of no use.
  • Companies have tunnel vision – see world through eyes of product.
  • Identify the mirrors of their attitudes – for example fridge, starts off easy to store food instead of market, then changes to store snacks as income rises.
  • Culture in society will remain constant.
  • Identify these cultural factors – collection of common values as individuals.
  • It dictates behavior in a group or society.
  • Values never go away, just get re-prioritised.
  • Build culture maps.
  • 4 C’s – conservative, competitive, compassionate, conservative
  • Conservative – China india – travel by home by train, eat at home.
  • Competitive – eat catering, innovative fast food.
  • Creative/Curious – cuisine, foodies.
  • Compassionate – Sustainable consumption.
  • Healthcare can change with shifting values – how?
  • Indonesia, India – Changing back to conservation, don’t want to leave back cultural values. Buy insurance for parents don’t want to leave them in villages. Pilgrimage tourism, natural ingredients, halal cosmetics.
  • China moving towards developed world.
  • Redefining Islamic lifestyle – leah changed her career from architect to e-commerce selling clothes.
  • Women home entrepreneurs are starting to grow in India. They have a found a way to create a business at home, and bring money home and increase GDP.
  • Fintech – is revolutionizing this whole process. She can pay all her employees through her smartphone which will create a credit profile and allow her to access finance and grow her business.
  • This technology has started in the East and is spreading to the West.
  • Need to think of culture with companies.
  • Value map your investments, employees, suppliers, clients. Think of the 4 quadrants and build cultural maps.
  • Stories show how trends take place and display the paths and trends taking place.
  • India has many conflicting values – tinder but for marriage.

Hamish Douglass – Hamish Douglass is Co-Founder, Chief Executive Officer and Chief Investment Officer of Magellan Financial Group.

What do you consider to be the biggest challenge in building future proof portfolios?

  • There’s always a lot of change, esp over 30 years, but portfolios have done alright. There’s always risk. Shouldn’t be scared. If im thinking about the future – work out where wind is blowing. Think about with wind in the sails. Don’t want to go into headwind and go backwards. Tailwinds have been strong, bond markets and QE. Tailwinds may turn into headwinds. Mark says we’re going into a headwind economically, as policies reverse. Think about the headwind and position yourself. AI and digitalization will create massive tailwinds and headwinds. Think about where winds are blowing, and position yourself where wind is blowing. Be with the wind.

What is key take out from Mark and Tassos?

  • Hamish says both speakers spoke about predicting future themes. Mark, economic theme prediction and being predicted. Whereas Tassos predicting future from culture, which predicts trends. Think forwards not backwards, as history doesn’t repeat itself. If you understand culture or economic shifts you can predict future.

Finology – In our society, it’s critical that every individual has a clear perspective about money, and the role that it plays in their present and future well-being.  But money means different things to different people. People also have different perspectives on money, based on their past experiences. Finology explores the relationship between human beings and money in our society. It is the emerging (and converging) research field covering the study of minds, customs and behaviours with respect to money. It incorporates behaviour finance and much, much more.

 Artificial intelligence – What’s to come next

  • 1995 world wide web directory was developed.
  • Big structural changes that take place are often underestimated. As in the case with world wide web.
  • AI is a structural change – it will change the way we invest.
  • Use of AI aready widespread. It was first coined in 1956.
  • Computing power wasn’t there. But has now changed.
  • Machine learning is used in credit checking – whether your good credit or not.
  • Why taking off now – data availability – machine learning needs lot of data. A lot of data was collected 2017/18. Computing availability – prices have fallen. Computer speed – GPU. Changed the pace of computing power. Machine learning works so much faster with more powerful computers.
  • Eye movements during every behavior predicts personality traits. Are you neurotic?
  • Humans are often human.
  • Brain can store 2 petabtyes of data.
  • Cloud can be stored via Google is now dramatic.
  • We don’t work 24 hours a day. Computers don’t sleep or forget things.
  • Not always most efficient.
  • History doesn’t repeat but it rhymes.
  • AI – has its challenges but it will dominate in the future and within financial markets, the capital is there and desire of investment community is there.
  • Predict – it will create new ways to invest. New competition to what we do.
  • We make human based decisions. We are a source of good return / creativity only if we do it well.
  • 1990 – Pretty Woman – Using the fax machine / developing quant models.
  • Behaviour – admit it computers and data is everywhere. What are the behaviours we need to think about?
  • Admit to mistakes – how can active managers adapt to win machines?
  • People are bad at admitting mistakes, its not part of human nature.
  • Best way to move on – is to recognize and get on with it
  • People trust you significantly more if you admit mistakes first.
  • Second – Change How do you think?
  • Reactive thinking or control thinking. Take your time to think. Foxes and Hedgehogs.
  • Hedgehogs think of one big idea. Doesn’t listen, doesn’t admit to mistakes.
  • Foxes – Have many ideas. Adaptive. Willing to embrace change.
  • Disengage your ego – Is a massive headwind. Gets in the way of making good decisions. Jamie. Egotistical person can ruin a team. Get the ego back in the box.
  • Socratic learning – Hypothesis out there to be debated. Ideas should be believed and put out there.
  • AI Investing will – become a notable competitor, do not underestimate it, it will grow rapidly, learn from mistakes.
  • Active investing will – adopt the right critical thinking, adopt the right behaviours, make smart human decisions.
  • In the age of machine only active managers who can make smart human decisions will be winners.

Airlie Funds Management – Airlie has an active, value-based investment style that aims to deliver attractive long-term capital growth and regular income to its investors. Founded in 2012 by John Sevior and David Cooper, and headquartered in Sydney, Airlie manages a range of Australian equities strategies, primarily for institutional and high net wealth clients. Two speakers today are Matt Williams and Emma Goodsell.

  • Matt  Williams & Emma Goodsell PM
  • Alan Wilson REH story reece plumbing – investing for future
  • The right owner managed businesses provide a solid backbone to a portfolio and will help future proof portfolios.
  • Shareholding > 20% have high control. That means its an owner owned business.
  • <20% families that own less but still have control, Westfield and Lowy business. News Corp is another.
  • Minimum 10 year history.
  • Owner Managed Index – 40 names. AAC, AGI, APE, ARB
  • Index has done well.
  • Try get this owner managed index –
  • 3- behaviours have done the index well.
  • Focus on core – good owner managers grew up with business and know the company well, close to market and close to customers. FLT – good example.
  • Long term planning – They can withstand pressures of short term market and play the longer term game.
  • Owner managed companies can take long term plans and take a balanced view.
  • Resilience – Asset rich. Lot of property on balance sheet. Lot of assets, cash, balance sheets strong, optionality to take opportunities.
  • EMMA – Met with son of REH.
  • Asked about synergies about new deal with US deal.
  • Night before del his father was as excited as back in 1969 when he took control. That kind of culture and emotion worked well.
  • High ownership, high control – Reece compare to tradelink. Same but different ownership structure.
  • Focus on core – First plumbing hardware store opened 1920.
  • Investment in store network.
  • Long term planning – 50+ engineers.
  • Graduate 30 Employer in Australia – start off in retail first, before putting in head office.
  • ARB – 1975 business, founded in garage, and is now Australia’s leading 4WD company.
  • Export globally as well.
  • 2nd definition – low ownership, but high control is also what they invest in. A good example is Westfield and Lowy and Murdoch family and News Corp. Milner family – Soul patts.
  • Conclusion – right owner managed business have managers with considerable skin in the game >20%.

Western Asset Management – Unconstrained investing

  • What is a practitioner’s dilemma – it’s an uncertain world.
  • With all the $10 trillion of neg rate bonds, will it explode one day.
  • Declining yields have been falling for 30 years.
  • ASX 200 similar problems – good return from materials. But it is skewed. Benchmarks are a flawed set, incomplete set.
  • There is no one asset class that outperforms year after year.
  • Unconstrained investing –Is an investment style that does not require a fund or portfolio manager to adhere to a specific benchmark. Unconstrained investing allows managers to pursue returns across many asset classes and sectors. *Basically it’s a do anything approach.
  • Absolute return – principle protection.
  • Unconstrained – no one size fits all solution.
  • Broad or no representative benchmark.
  • No anchored to a traditional asset allocation framework.
  • Uses fundamentals, valuations, and technical.
  • Ability to capture this all in the formation of the investment thesis.
  • Able to rotate throughout diverse asset classes to gain alpha.
  • Flexible, go anywhere investing.

Blockchain – Chris Berg, PhD

  • The idea of decentralisation.
  • The blockchain is a decentralised technology. … A global network of computers uses blockchain technology to jointly manage the database that records Bitcoin transactions. That is, Bitcoin is managed by its network, and not any one central authority.
  • Academic believes Blockchain technology to take over soon.
  • Can be used in all facets of life.
  • ASX, voting – anything that has a list can use a blockchain.

Thursday – Day 2

Investment Committee Meeting Agenda – Mock meeting – Panel discussion.

Designing portfolios for scenarios is critical to future-proof portfolios – Graham Rich, Jeremy Lawson, and Expert Panel.

  • Brett – Why have we had such low growth in last decade? Globalization of labour market and cost pressures in technology pushing down, export prices flat. Balance sheet recession is the main reason. Recovery takes time because of this reason.
  • Bridgette – Doesn’t agree. She doesn’t believe that we’re there yet with driverless technology. Shrink down the number of systems. I don’t agree.
  • Kerr – Concern about Chinese debt.
  • Tim – this is where we are, and its hard to see anything dramatic happening in next 12 months.
  • Mark – 30 years getting to this scenario and now we’re. Inflation doesn’t develop due to interactions in the world. Low economic vol.
  • Scenario 2 – Bear case continuation of trade war US China. Nafta breaks up. Growth slows, recession is plausible. Asian economies take a hit, Australias export economy will soften. Terms of trade deteriorate and economy will weaken.
  • Mark – Global labour market has a biomodal distribution. But there is a disequilibrium. People want to protect their patch, which is competition between people.
  • Kerr – US isolationism. Shortage of capacity. Continued investment. But he doesn’t feel we’re on the edge of economic activity falling but he does acknowledge China is falling a little.
  • Tim – North Korean road map. Create problem. Pretend to sole it from the start. Declare victory. Move on. China – Trump make a big problem, create a crisis, have a meeting.
  • Chris – Trump pro free trade. What hes trying to do is get wins against Europe and ultimately with China. In order to get this scenario, Europe doesn’t have tech. They are struggling in that space.
  • Brett – What is Trumps end game? Bearish scenario if this escalates. End goal is to lower tariffs. This trade war might be solved or it could last right throughout.
  • Scenario 3 – Bull scenario. Fears of trade war are overblown. Other economies come to trade table, globalization gets a boost.

Stream of consciousness – Investors like to have their cake and eat it – that is, they like investment returns (the higher the better), but dislike volatility (particularly negative returns) but they don’t mind positive skewness (the characteristic that causes people to buy lottery tickets even though the expected impact on their wealth is negative). It is possible to engineer investment returns that meet those requirements, by using portfolio insurance to protect a portfolio. The bottom line is that investors can have their cake and eat it, by being better off in terms of all the three characteristics that investors favour. ‘Future-proof’ is too hard but we can better meet client needs – Professor Ron Bird.

  • Amount of factors to predict stocks are limitless in comparison to horse picking
  • Task is too complex when you multiply this across 1000 securities and many tens of asset classes
  • Luck is the winner and what professionals have to offer is highly questionable.
  • Bad outcome? – Getting poor returns. Large volatility. Large drawdown. Negative returns.
  • $1 loss is equivalent to a $2 gain
  • Rely humans to future proof performance – won’t happen
  • People like returns but don’t like volatility
  • Same people have the same preferences
  • Design products to meet preferences
  • Should we do that? Is another matter
  • Protected put option
  • Protects the downside but on the upside investor will pay for the insurance
  • Avoids negative returns
  • 150 investments only and a reasonable portfolio of max 10 – 1.2*10*15
  • Machine learning – will use the right way to solve knapsack problems is to use methods or algorithms.
  • Quants do best –
  • Average trader does better in the market
  • Market does worse than the average – the average person does better than the market
  • Individuals can do well
  • Take home -finance problems are about choosing the right things to continue.
  • Machine learning is not effective for selecting the right portfolio. Years of big data doesn’t help
  • You need a methodic approach
  • And you’ll beat the market
  • Train yourself
  • The average fund manager does worse than the market because of fees.
  • IT’S NOT ABOUT COLLECTING MORE AND MORE DATA. 

Ian Paczek – Investors need style neutral global equities exposure. We all know about the drivers of investment returns, often referred to by ‘style’ or ‘factor’ – but when to pick which ‘style’ remains one of the most difficult disciplines of investing. As computing power has increased, so too has our ability to identify more of the underlying components of performance and better understand the relationships between these factors. Investors are rightfully benefiting from increased scrutiny around ‘pactive’ portfolios which charge high fees to replicate cheap (naïve) factors. But the more valuable evolution is a consideration of how to build stronger portfolios for Australian investors that already have meaningful style biases. To help future proof portfolios by improving the accuracy of intended portfolio risk, investors should consider using a style neutral option, particularly for global equities, to offset the likelihood that they are already invested in heavily style biased portfolios.

  • UBS senior PM and Executive Director.
  • Measurement of risk – mathematician.
  • Market environment and background – over last 10 years. What worked in one year didn’t work the other. Use style ranking calendar per year.
  • It’s proven difficult. 2017 was momentum. 2016 – was value. 2014/2015 – Market Vol.
  • If factor timing the answer? Difficult. Momentum works until it doesn’t.
  • Diversify across factors? Not easy. Correlations are not stable, even in undisrupted markets like in 2017.
  • Law of active management – theory. IR = skill * breadth * transferability.
  • Theory & Analysis – know where insight and skill lies. Independent ideas and differentiated stock positions, avoid unintended factor tilts.
  • High skill required for low breadth. Low skill but high breadth. Somewhere in the middle is where porridge is – goldilocks zone.
  • Not thematic ideas.
  • Measuring risk is key and measuring it consistently.
  • Know where risk is coming from.
  • Portfolio optimization – is a tool to achieve an objective.
  • Conclusion – Align risk with the alpha insights for an efficient portfolio
  • Unintended biases can increase risk without increasing alpha, decrease breadth and decrease alpha.
  • Independent ideas are essential ingredient in achieving sufficient breadth.

Michelle Lopez, – CFA, Senior Investment Manager, Aberdeen Standard Investments (Sydney) Good governance is a strong amplifier of small cap performance – Many of Australia’s small companies are our potential future leaders. The ASX 300 provides active investors a universe that increases the ability to deliver long-term alpha and greater diversification, helping to maximise potential long term returns. A sharp focus on corporate governance can assist investors in identifying those high quality, sustainable businesses that can last the distance thereby ‘future proofing’ a portfolio. Best practice in corporate governance can deliver better returns in the medium to long term for investors when harnessed with the potential growth of good quality Australian Small Cap companies.

  • Michelle Lopez – Aberdeen Standard Investments
  • Anaylsing good governance in companies – strong governance amplifies performance longer turn
  • As companies transition from small to large – it happens
  • More volatile the market is – the greater it is for an investment to add value.
  • Small Cap Ordinaries offers better opp to generate alpha as its more volatile
  • Top 20 ASX 200 – makes up 60% of index
  • In the small ords – top 20 make up 27% index
  • Large caps – banks / miners in ASX 200 Index
  • But in Small caps – more diversified
  • Opportunities are better but increased risk
  • 44% of small caps have posted negative return
  • 25% have halved in value
  • 26% doubled in value
  • In large caps only 2 have halved in value. So you need to be mindful when investing in small caps.
  • How to pick the right ones – ESG is the answer combined with ownership, financials, management and business strategy.
  • Companies  that do adhere to good governance do well.
  • Why? – Why matters?
  • ESG factors are financially material, and impact corporate performance.
  • Understanding ESG risks and opportunities alongside other financial metrics allow better investment decisions to be made.
  • Helps foster better performance, protecting and enhancing the value of clients’ investments.
  • Small cap part of market is even harder.
  • Case studies – DMP high growth market darling. ESG is not an issue until it is. Grown 700 stores to 2100 over 7 years. 2/3 offshore. Its share price halved. Wage manipulation. Difficult to pick. Red flags – not one facility was certified to global standards and food safety. Financial risk, growth come from acquisitions from organic growth. Number 3rd party transactions, selling then providing vendor finance. Rent structure – executives incentivized to get store rollout, funded by debt.
  • Cabcharge – Fallen $8 to $2. Thrived in no competition. 2014 – Uber came into market. Unprepared.  Aberdeen tried to get stronger governance. Engaged with board. 2 independent directors. Worked with management to release sale of property investment they held. Long term strategy – app development.
  • ARB Corp – Gone from $3 to $21. 4WD components, stared in garage. Family owned. Fundamental drivers. Monopoly. Never raised equity. Acquisitions. Organic growth.
  • Best practice in governance delivers better returns.
  • Good governance is a strong amplifier of small cap performance
  • ESG matters and can help make better informed decisions.

China will be a high-tech global power within two decades – Linda Jakobson CEO, China Matters (Sydney). The People’s Republic of China (PRC) invests heavily in high technology research. It is set to become a global power within two decades in numerous spheres including nanotechnology, artificial intelligence, space exploration, and medical research. The world will certainly benefit from the PRC’s technological ambition. For example, PRC scientists are expected to find long sought-after cures to deadly diseases. However, PRC technological prowess also has challenging implications, starting with PRC ability to steal technology and conduct cyber-attacks as well as the development of forms of social control which are contrary to democratic norms.

  • Linda Jakabson – FD & CEO.
  • PRC – 5 year plan.
  • Quantum communications and computation.
  • Brain research.
  • Economic growth is slowing – transforming to labour intensive / resource intensive into one that is increasingly dependent on technological development.
  • Chinese R&D expenditure is almost on the same level as US.
  • Top 20 – most innovative economies.
  • Australia rose to 20 place having being 23rd
  • China number 1 issuer of patents.
  • China is well known for questionable quality – novelty. But its been a massive leap to leading the worlds patents.
  • Around half of PRC bachelor are in stem fields. Science / Tech / Engineering / Maths.
  • 4m graduating in China compared to 377k in USA.
  • Doctorates in China has surpassed USA.
  • Made in China 2025.
  • Chips computers and systems, industrial robots, airlines, ships, railways, eco smart cars, renewables, agri tech, pharmaceutical.

Nick Griffin, Founding Partner & Chief Investment Officer, Munro Partners (Melbourne) – Future proofed portfolios need growth equities.

  • Growth investing is essential to future proof a portfolio.
  • If investing in equities and following the index then by definition, an investor is investing in growth.
  • However, investors should learn the lessons of history.
  • When powerful structural changes occur, it creates very divergent paths for different companies (even in the same industry).
  • Structural growth companies can easily grow into their higher near-term valuations, while stocks trading a ‘cheap PEs’ but on the wrong side of structural change are seldom protected by their valuation.
  • Looking beyond near-term valuation multiples can help identify the next great winners and also help avoid the losers.
  • Without growth investing, a portfolio is only focusing on only one side of the equation.

Cyber conflict is a threat to future proof portfolios – David Sanger

  • David Sanger – NY National Security Correspondent.
  • There are two kinds of big companies in the US. There are those who’ve been hacked by the Chinese and those who don’t know they’ve been hacked by the Chinese.”
  • In the cyber world today, we are somewhere around World War I.
  • A decade ago, there were three or four nations with effective cyber forces.
  • Now there are more than 30. There are the “Seven Sisters” of cyber conflict – the US, Russia, China, Britain, Iran, Israel and North Korea – although nations from Vietnam to Mexico are getting involved.
  • Many have started at home by testing their cyber capabilities against dissidents and political challengers. But no modern military can live without cyber capabilities, just as no nation could imagine, after 1918, living without airpower.
  • And now, as then, it is impossible to imagine fully how dramatically this invention will alter the exercise of national power.

Finish.