KT: I think the investment management process has become much more quantitative in nature and also more diverse in terms of both asset classes and portfolio construction techniques. Twenty-five years ago, managers offering quantitative-oriented strategies were viewed with considerable skepticism, a not unusual reaction to new and different offerings.
And, in fairness, the quantitative managers often didn’t do themselves any favours as they struggled to explain the nuances of their ‘black box’ approaches.
The sophisticated risk analytics offered by BARRA(a money management consultant in Berkeley, CA)were just beginning to be used in the U.S. market and had barely been introduced into Canada. Modern portfolio theory concepts such as portfolio optimization and risk budgeting were likewise rarely, if ever, used. The only type of hedging really used was currency related and even that was infrequent since the foreign content limit was just 10%.
Today, virtually all managers make use of computer analytics to some extent. Enhanced indexing strategies(as the original quantitative strategies have generally become known)have become a widely accepted and popular investment approach as their risk-controlled return stream provides a reliable core portfolio holding. Likewise, optimization and risk budgeting have become mainstream techniques for managers, plan sponsors and consultants alike. The acceptance of these techniques has supported the growth and adoption of many alternative investment strategies and the development of new asset class sectors such as credit default swaps.
BC: What has been the biggest surprise for you over the past 25 years in this industry?
KT: I’ve been surprised and disappointed at the trend away from defined benefit(DB)plans. While I understand the cost impacts that a DB plan can have on the sponsoring entity’s financial health, research has shown that the overall costs to a company for a defined contribution(DC)plan are not that much less—that is assuming the DB plan receives the requisite employer contributions and is invested appropriately with close attention paid to asset/liability mismatches.
What is truly crucial, is the transfer of investment risk from the employer to the employee that occurs with defined contribution plans. Few DC plan participants have the knowledge, interest and/or time to effectively manage their own plans which, as we read regularly, does not bode well for their financial security in retirement. Insufficient attention has been paid to developing solutions to some of the weaknesses of DB plans such as lack of portability while preserving the important advantages of this plan structure.