Asset allocation challenges for Chief Investment Officers (CIOs) 

With inflation remaining high around the world, and all eyes on how central banks will respond, CIOs are operating in a particularly uncertain economic environment. In July, we asked a panel of three CIOs – including one of our own – how they are handling their critical investment decisions. The discussion centered upon the need to adapt portfolios and strategies to changing environments and the challenge of remaining agile without simply reacting to short-term triggers, which can come in many forms.

A key challenge facing our panelists has been higher inflation. As well as an impediment to generating real returns, high inflation complicates guidance by APRA, the prudential regulatory body in Australia for banks, insurers and superannuation funds, for mean annualized estimates of net return to exceed growth in CPI. The regulator’s Annual Performance Assessments have been in place for some time but have now become a more prominent issue for institutional investors, who see high inflation as making the criteria increasingly challenging.

“If you don’t pass the test, you don’t get to play – so it matters,” panelist Corrin Collocott, CIO of Mercer Super and Multi-Sector told the audience. As to whether this was going to spark more discussions in the industry, Corrin said it already had.

“We are having that discussion with trustees because, especially with lower risk portfolios, we have hit instances where we have failed to meet CPI objectives over long timeframes,” said Corrin.

He explained he was against readjusting CPI objectives in the current challenging environment precisely because many longer term investors have experienced the opposite, with funds experiencing excess returns above CPI, even if some of their newer, younger investors have not.

“In reality, we have an array of people [many of whom] have enjoyed good returns and we should bring that into the equation,” he said. “We should be measuring ourselves in rolling periods over time.”

This view of a longer, broader context may be lost on retail investors, however, with inflation having a significant impact on day-to-day affordability in many countries around the world. Panelist Matthew Drennan, CIO and Head of Unit Linked Business for Zurich Australia, said: “What investors are concerned with is growing and maintaining their wealth in real terms. They just want to see what real returns can be generated for them and how they build their wealth for retirement.”

Tasked with heavy responsibilities and a challenging investment environment, the CIOs on our panel face a daunting outlook. And they have had to contend with many other challenges beyond inflation and interest rates.

While there are myriad ways to implement ESG into portfolios, the CIOs were united in taking a rigorous approach to holding their underlying managers to account.

“We are not looking for idealistic answers from our managers around their approach, but clear and precise reporting and measurement metrics," said John Lucey, CIO at Resolution Life Australasia. “We have our own independent systems running over the top of our portfolio to see the scores that come out on ESG metrics, to prove what we’re being told is actually happening."

Pursuing ESG criteria has become complex and this presents a challenge for CIOs, who have to align underlying portfolios with high-level, overarching targets. As a result, Matthew said this was forcing him to look at ESG in a nuanced way.

“Look at a company like BP. It is investing a billion dollars installing electric charging stations around the world,” said Matthew. “Engaging with that is a better way of getting the outcome we want than carving out a huge segment of the benchmark and not investing in it.”

The sheer flood of varied or conflicting information influencing markets, in all manner of areas, was highlighted by John, who pointed to markets being impacted by retail investors who are always just a few screen taps away from macroeconomic noise. “It’s never been harder to remain disciplined,” he said.

“Perhaps it’s not a concern from an institutional perspective, but it’s never been easier for someone to log onto their superannuation portal and change from high growth to cash because they’ve seen something on social media.”

In a similar vein, Matthew told the audience that a reluctance to pay for active management could be a risk in a higher rate environment.

“Low fee index products are great when you have low inflation and rates, but if you need to be more selective you need to pay for it.”

Whether it is in response to inflation concerns, regulatory restrictions or swings in the public mood, CIOs face a peculiar demand to balance their strategies between agility and stable continuity. Often, that task can be affected by the world’s misalignments, such as between legislation and the economic reality, shared ESG ambitions but inconsistent ESG frameworks, the battle between information, misinformation and information overload – and far more besides. Finding that balance will demand more than ever from CIOs constructing, assessing and adapting their portfolios in a world where all of those challenges are only likely to grow.