In this, the third and final blog post summarizing the key takeaways from the Trends in Institutional Investing: Allocation and Predictions for 2023 webinar, we focus on the topics of quantification and internalization.
The blog summarizes insights from a panel discussion moderated by SigTech’s Daniel Leveau between Andreas Clenow, Chief Investment Officer at the Swiss-based family office Acies Asset Management and a best-selling author quant investment strategy books, and Eric Battesh, VP of Alternative Investments at the US insurance company Selective.
Quantification
Quantification is one of the most prominent trends in the investment management industry. Investors increasingly embrace the use of new technological advancements to profit from the digitization of different parts of their value chain. Easy access to powerful technology allows discretionary investment managers to become more technology-driven and to systematize parts of their investment process.
How do you see this trend playing out? And, what opportunities – but also challenges – do investors that are starting to embrace quant investing and analytics face? What is your advice to them?
Andreas Clenow: ‘On the one hand, I encourage everybody to move into the quant space, but, on the other hand, it is, as with most things, easier said than done. You need to set realistic expectations about what you can achieve and how you should go about doing it.
You need to address issues such as how much you should invest in building up internal resources compared to working with external partners? Key is to identify the specific major pain points you expect to encounter and find an optimal way of solving them.
In general, basic knowledge of quantitative investing is currently much more accessible than 20 years ago. But, It is surely an illusion to believe that you can read a book or two and create quant strategies that are expected to perform better than those built by somebody with a long-term track record.
However, with that being said, the ability to quantify investment processes has changed dramatically for the better over the past 20 years. Back then, you mostly could access some retail type of scripting language platforms where you could draw some lines or create a couple of moving averages and essentially hope for the best. Since then, the number of quant tools, and particularly the quality of the tools, has improved significantly, making it much easier to create and run systematic investment strategies. The same goes for data availability, although data quality is still sometimes an issue.
The ongoing quantification has also made it easier to review investments in externally managed funds. Reporting nowadays focuses a lot more on quantitative measures, making it easier to get an in-depth understanding of an investment’s true return and risk numbers.
All-in-in, I believe the trend of quantification will continue to be beneficial for investors.’
To get a better understanding about what trends are reshaping the investment management industry, SigTech conducts its yearly Institutional Investor Report. In reference to the topic quantification, the study shows that nine out of ten institutional investors believe that systematic analysis increasingly forms an integral part of the investment process. Furthermore, as a logical consequence, 80% of investors expect to increase their budget for data and tech infrastructure over the next two years.
Risk of private market investments
As seen in our Institutional Investor Report, the big appetite for private market investments is intact, while the performance gap between publicly and privately traded assets widened in 2022.
In addition to the stronger return numbers, the stated risk levels of many privately traded investments are significantly lower than the risk levels of publicly traded investments.
Do you believe that the often lower risk levels of private market investments give a true reflection of the underlying risk? What impact does it have when you assess such investments?
Eric Battesh: ‘The first question to address is on what basis do you view risk. You can either do it from a pure accounting basis, in which you make use of quarterly return numbers posted by investment managers, or you look at it from the perspective of changes in the underlying fundamentals of the investments.
As neither can be measured at a high frequency, for instance daily, it will per definition result in a smoother return pattern for private market investments compared to investments in publicly traded securities that are exposed to a continuous valuation.
If we focus on private equity and go back in history and review how it has performed during periods of larger sell-offs in the stock market, private equity has lost roughly half as much. During these periods the volatility has also been lower.
If I look at our own book and how it has changed in the past, what I care about are the quarterly marks on our private market investments we receive from our managers. If you try to assess it at a higher frequency, it can be very difficult to learn much from that.
A way to assess if the managers are actually marking positions where they should, is by reviewing when they are exiting a position. Are they generally exiting at a position below, at, or above the latest mark? From my experience, private equity firms look to exit at a 15-20% uptick from the latest valuation. We have not yet seen any losses at exit, at least not in the buyout space.
If you look at return expectations, many investors expect private equity to post significantly higher return numbers than public equities, which I do not necessarily agree with. But, I believe it is a great asset class and I expect the volatility to continue to be less than for public equities.’
Andreas Clenow: ‘I follow the heated discussion about ‘volatility laundering’, but I think you first need to question if volatility is a sensible risk measure for private market investments that per definition have less frequent mark-to-market valuations.
The only way to truly mark them objectively is when there is a transaction in the market, for instance from a new financing round. Valuations in between are anybody’s guess. So, I do not believe volatility is a great risk measure to use for private market investments. Another point of volatility laundering, if you will, is that you need to be fully aware of what assets the fund is invested in. We see a lot of structures offering attractive liquidity terms to investors, despite the fact that they are invested in private assets that are very hard to trade short-term. This can result in redemptions being gated and part of the investment ending up in a side pocket that you cannot liquidate on your terms. You should thus be very mindful of the structure in which you invest.’
Asked about if they mistrust the stated risk levels of private market investments, nine out of ten (89%) of the institutional investors surveyed for the SigTech Institutional Investor Report believe it is a real concern. However, evident in the responses to a previous question around trends in asset allocation, it has not yet manifested in any material changes to institutional investors’ allocation decisions. Institutional investors have a persistently strong appetite for private market investments.
Disclaimer
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