1. 1 Portfolios after the fun Peter Holland Fidelity

2. 2 It’s the people, stupid! We are very clever –Large spreadsheets –Information overload But also very dumb (greed/fear) -The origins of today’s problems -What will the “industry” do? -What ought the “industry” do? -The “Octopus” solution

3. 3 A Glorious Bull Market

4. 4 The Bull Market Valuation driven –Transition to low inflation world Equities became the asset class of choice Bonds & Property were for wimps “Greed” took over –Benchmarking became the norm –Ownership replaced by derivatives, “vehicles”, “products” –Timescales contracted –Confidence increased

5. 5 The New World

6. 6 What went wrong? Sub-Prime, credit etc –The “engine” was forgotten –The “back testing” was unrealistic –Investors were confused by complexity –Risk was moved, not eliminated (moved to the ignorant) Economic or Behavioural? –Incentives – bankers – “products” not loans –Front end fees/profits preferred to sound lending –Rating agencies – paid by the “product” generators –The short term “rear mirror” view of risk –The great fee conspiracy (fees change behaviour, risk perception) The world of investment management couldn’t cope with lower nominal returns. 4% from bonds; 7/8% equities – inadequate!

7. 7 The benchmarking cancer Benchmarks drive manager behaviour Incentives – “benchmark risk” takes over Timescales shrink Losing money is irrelevant All judgements are relative The economic driver is lost Managers become obsessed with the “big bets” Pensions: –Liability calculation change – benchmark – portfolio –“Process costs” are high Why does conservatism appear after markets fall?

8. 8 Turnover...

9. 9 Fixing it? Identify the cash generative capacity of asset classes. –Align expectations (no free lunch) Get real on fees –Total return of 8% minus 1.5-2% fees??? Fix incentive issues –Bank loan officers, rating agencies, fee-greed Fix the rear view mirror! –LTCM modelling, eg –The world changes – annoying but true Benchmarking behaviour should change –Measurement role only Investment timescale; asset ownership

10. 10 The reality... Regulatory expansion & conservatism –Based on the recent past (not the future risks) –Portfolios will become more “conservative” Equities, Property, Bonds Hedge Funds/Private Equity The DB trend (vs DC) New asset classes (commodities, weather/carbon/forex trading!) Fees will remain too high in relation to actual returns Absolute Return investing? The Philosopher’s Stone – a portfolio for all times? Ownership & economic driven investment? Fees, vested interest, complexity?

11. 11 The Octopus’ Assumptions Macro driven Economic returns (the “engine”) matter The AWFUL TRUTH – cheap, simple, long term is GOOD. Cash income matters Past correlations, little help –Economics behind correlations matter –Current & future correlations matter No “long term” asset profile (the world changes) Major asset moves needed occasionally Cash/Benchmark for measurement only Asset ranges set –Equities, 25-75%, Bonds, 0-50%, Property, 0-50%, Cash, 0-25% etc –Continuous review (not quarterly)

12. 12

13. 13 Octopus contd Today’s world –Global ($) growth driver is “new world” not “old world” –Em market equities are less risky than generally perceived –Material shortages will remain for a while –“Old world” inflation is picking up –Developed mkts – inflation linked bonds are good (fixed, bad) –Equities are good value –Geographical approach to equities is ill conceived Sectors, types, stock specific, balance sheet etc matter Utilities, resources, infrastructure Currency – I have no skill Humility

14. 14 So far... Octopus benchmarks – Cash plus 3.5% and my “Institutional” benchmark: –25% UK equities, 20% ex UK equities, 20% fixed interest, 20% index linked, 15% property Vehicles: ETFs, closed end funds, stocks (for “tilts”), cash Outcome (since inception) +3.6% ve benchmark & +6.1% vs cash. Since July 2004. Very early days!

15. 15 Conclusions Markets are dealing with the excesses –Root problems are human not statistical Dealing with greed, poor incentives, high fees is TOUGH. Losses and chaos will purge some of this but far from all Conservatism (voluntary and regulatory) will increase till markets do better Many liability driven funds will (and ought to) close down the risks (DB>DC; buy-outs)