by Evgenia Gvozdeva, Ph.D., & Nick Zylkowski, CFA, Russell Investments
As an institutional investor, there may be nothing more important than establishing your investment strategy, maximizing the efficiency of your exposures, and defining strategic beliefs. But if your portfolio is not aligned with your strategic positioning, then all of those efforts may be compromised in achieving overall investment objectives.
The best-designed multi-manager portfolio can move out of alignment from your preferred positioning. Even a small misalignment, over time, can result in unintended risks and a significant diversion from the path of your strategic investment beliefs.
This is why we believe it's critical to partner with a provider with a comprehensive portfolio toolkit that allows access to custom exposures. Because this approach is designed to keep your investments precisely aligned with your investment beliefs, we see it as taking the power of a multi-manager approach to the next level.
The challenge: Unintended exposure gaps and risks
As soon as an asset owner allocates capital to more than one manager, an interaction effect exists, which will impact the investor's overall portfolio outcome. What unintended risks result from the combination? What desired exposures are not covered? How does an investor manage these gaps and overlaps? These are all important questions to be addressed when managing for a total-portfolio outcome. Unfortunately, for the asset owner, the individual managers are not able to do this on their own.
Why? By design, money managers are not privy to each other's holdings. They are focused on delivering excess returns from their specific area of investment expertise. Because of this, their unique investment insights are reflected in their respective sleeves. But there's a drawback: the so-called agency problem: Unintended risks may emerge in the overall portfolio due to the interaction effect between managers. Simply put, the combined positions of all managers may result in a bias toward a particular risk overall related to sectors, regions, or factors. These risks may not be fully aligned with the investor's preferred positioning based on long- and short-term investment opportunities and desired risk allocations.
So, what's the investor to do? How can these unintended risks and biases be removed so that the overall portfolio is aligned the way the investor wants it to be?
The solution: Completion portfolios
Completion portfolios are a powerful tool for an investor allocating to multiple manager strategies. The explicit role of these completion portfolios is to complement the existing managers and align the total portfolio with desired risks and exposure. The completion portfolio can manage that interaction effect.
What are completion portfolios?
The three benefits from completion portfolios
Why incorporate completion portfolios within multi-manager funds?
- Improved control of exposures
Ensures your aggregate portfolio is aligned with your strategic beliefs, and not being driven by unintended risks.
- Improved risk-adjusted returns
By ensuring risks are effectively controlled
- Reduced cost of production
In many cases, including a completion portfolio will reduce total cost expenditure on managers
Exploring the benefits
Improved control of exposures
Completion portfolio strategies can provide a systematic way to solve for misalignment in portfolio exposures. They can help align the total portfolio with preferred positioning. And they can improve an investor's portfolio's overall risk and return outcomes. Our clients use completion strategies to make deliberate decisions on which exposures are intended and unintended and to be able to manage the total plan's exposure. They also incorporate exclusions or ESG preferences into a completion portfolio.
Improved risk-adjusted returns
For investors to achieve their desired long-term outcomes, portfolios must be managed to benefit from long-term return sources but with the ability to respond to short-term market risks and opportunities. At the same time, risks must be managed appropriately throughout evolving markets. Russell Investments' completion portfolios help investors achieve these outcomes. And clients can leverage Russell Investments' analytic engine and tools to see risks and exposures in real-time at the total-plan level.
Reduced cost of production
In many cases, including a completion strategy can help reduce the total cost expenditure on aggregate manager fees. It may also minimize turnover, trading, and required transition costs.
Four ways to use completion portfolios
Investors use high-conviction active managers because they expect them to be a primary driver of excess returns through security selection insights. But these manager activities also generate many risks that need to be considered. Completion portfolios—which use security and derivative investments that target specific factors, sectors, regions, and currency exposures—help investors ensure risks are being managed and exposure gaps are being reduced while still allowing manager security selection to be the primary driver of overall performance.
1 Better management of factor and portfolio risks
Completion portfolios can ensure exposures to factor risks in the total portfolio are aligned with targets. This can mean reducing unintended exposure to volatility risk or targeting specific levels to other strategy factors, such as value, momentum, quality, or others. In addition, the amount of active sector or regional risks are managed.
2 Unshackling portfolio managers to focus on opportunities for alpha
By creating risk management at the total-portfolio level, portfolio-manager decisions are freed up to focus on high-conviction alpha opportunities. In recent years, PMs focused on growth managers, while the completion portfolio provided value and low-volatility exposure to balance risk.
3 Opportunistic allocations
When shorter-term opportunities arise in the market, clients can reposition risk in the portfolio in a nimble, precise, cost-effective manner.
4 Factor capabilities: The power behind completion portfolios
Completion portfolios are designed to precisely align your portfolio with your investment beliefs and then dynamically maintain that precision throughout turbulent, fast-moving market cycles. This precision goes far beyond asset-class definitions, to multi-dimensional factors, including value, momentum, quality, growth, and low volatility. Equity and fixed-income factor portfolios for each of these categories can be built across multiple universes.
We believe that the right investment solutions partner should be able to offer completion portfolios with customized factor definitions and weighting schemes—which can be implemented either within factor completion strategies or as stand-alone single or multi-factor portfolios. We also see quant input and additional overlay strategies, such as a decarbonization overlay, as nice-to-haves.
The bottom line
At the of the day, you want to keep your total portfolio not only precisely aligned to your beliefs, but also optimized to improve risk-adjusted performance and prevent unintended and uncompensated risk. We believe that partnering with a skilled investment solutions provider that offers completion portfolios is a vital step toward accomplishing this.