Industry Voice: Investing against the possibility of regime change

Investor behavior in the current market environment may ultimately transform the way fiduciaries approach portfolio management. Unquestionable, investors' demand for ESG and their response to Quantitative Easing (QE) have presented a variety of challenges. But are these merely cyclical episodes? Or are these developments indicative of a larger, industry-wide transformation? We believe that investment managers should be proactive, cautiously protecting against the possibility of both outcomes.

ESG

The global demand for sustainability and ESG-aware portfolios is transforming the way investors value companies. For a rising number of investors, earnings are not enough. With increased awareness around issues such as global warming, activists — even at grassroots levels — are effecting corporate change. Energy companies, in particular, have been affected. And they have begun to innovate. Whether the industry's nod to more environmentally-friendly policies are mere window-dressing or actual metamorphosis remains to be seen. But we believe that those of us with fiduciary responsibilities to our clients should be prepared to entertain the possibility that the sustainability movement is a long-term, industry-wide change.

Quantitative Easing

Love it or hate it, government stimulus across borders has significantly affected investor behavior over the last decade. The injection of liquidity into the market has markedly changed investment outcomes around the globe. A new scenario we should also contemplate: since the introduction of QE had such an effect, the withdrawal of QE may generate its own regime change.

Cyclical or Lasting Change?

The boundaries of industry reform are neither discrete nor easily observed. How many times have investment managers heard the rallying cry: "this time is different," only to find out it was more of the same? One of the worst mistakes a manager can make is to jump on a cyclical train just before it reaches its turning point, however seductive recent returns may seem.

With over 40 years in the industry, QMA has held steady through decades of convincing wolf-cries. Our systematic process, based on academic and economic foundations, is immune to such behavioral biases. We stood our ground through the growth-rally of the 1990's tech bubble, thanks to a process based on fundamentals. Of course, that time turned out badly for managers who shifted their portfolios on the belief that a new era had arrived. Disciplined managers such as QMA, who stuck it out through some very tough periods, were well-rewarded for their forbearance.

Fiduciary Responsibility

While individual investors can make up their own minds about macro events, fiduciaries have more complex responsibilities. We need to consider both sides of the coin at all times. We take seriously the responsibility to factor in the full damage that could occur if a cyclical change goes full circle. Indeed, this measured approach helped QMA's investment professionals prevent some of the worst mistakes in the tech bubble by highlighting just how costly a shift back to value could prove for those contemplating a late move to growth.

As a firm, we consider the probability of success for each economic outcome, and the likely impact of each. We attempt to position our clients for success if regime changes do occur, and try to protect them against risks if widespread changes fail to materialize. To do so, we model both pre- and post-change eras, testing potential outcomes to generate a picture of their likely impact on performance.

A portfolio prepared for multiple eventualities should be well diversified. As a multi-asset manager, we recommend moving beyond "the usual suspects" to a portfolio that includes managed futures, commodities and other alternatives to traditional bonds and equities. An adaptive process that seeks to effectively allocate to diversified assets as dictated by a systematic process may help managers cope with the uncertainty an investment regime change may bring.

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NOTES TO DISCLOSURE

The comments, opinions and estimates contained herein are based on and/or derived from publicly available information from sources that QMA believes to be reliable. We do not guarantee the accuracy of such sources of information and have no obligation to provide updates or changes to these materials. This material is for informational purposes and sets forth our views as of the date of this presentation. The underlying assumptions and our views are subject to change.

This is intended for Professional Investors only. All investments involve risk, including the possible loss of capital.

Past performance is not a guarantee or reliable indicator or future results.

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