The New Global Financial Order: Three Perspectives on Investing
India recently played host to a CFA Institute investment conference in Mumbai, in partnership with the Indian Association of Investment Professionals and the country’s National Institute of Securities Markets. The event featured three internationally renowned speakers: Roger Urwin, CFA, global head of investment content and advisory director at Towers Watson; Aswath Damodaran, professor of finance at the Stern School of Business at New York University; and Satyajit Das, a consultant, risk management expert, and the author of Extreme Money and Traders, Guns, and Money.
Urwin reviewed key challenges to the practice of investing posed by the “new financial order.” Damodaran focused on successful investment philosophies and what it takes to make them work. And Das tackled the subject of investment strategies for survival. Each of these presentations are highly relevant to investment practitioners everywhere. Here’s a recap of the main takeaways:
Roger Urwin, CFA: The Practice of Investment Management in the New Financial Order
In the so-called “new normal” environment, complexity and interconnectivity have increased, intensifying the challenges of managing investment portfolios. Urwin sees two high-probability macro scenarios unfolding: First, a bumpy path to recovery. Second, continuing financial repression. It is difficult for any single strategy to cater to both scenarios. A change in paradigm in investment practice is definitely underway, he said, although it is happening slowly and often is not noticeable.
The practice of portfolio management is drifting into the new trend of focusing on “smart beta” based on thematic investments, alternative asset classes, market anomalies, or risk factors as institutional asset owners start to diversify away from traditional “bulk beta,” which is generally associated with the classic asset mix of 60% equity and 40% fixed income with a long-term target return of the consumer price index (CPI) plus 3.5%. Asset owners will continue to pursue “alpha,” Urwin said, but they will be increasingly sophisticated in their understanding of capacity limitations and the difficulties in identifying truly skillful managers. Optimal allocation based on risk factor exposure rather than traditional asset class exposure is gaining traction, he contended, even though it is still not widely practiced in the industry.
Urwin also contended that successfully managing risk is becoming front and center in the practice of portfolio management. Risk must be captured in as wide a framework as possible, he said, considering all sources and facets of risk with particular regard to time horizons. From a governance perspective, risk must be approached with the right resources, responsiveness, thinking, and processes with special regard to decision making. Finally, effective risk tools need to include a real-time delivery capability to assess security-level details that are integrated into the overall portfolio context and that are consistent with the risk framework.
Additionally, the role of the industry and the government must be reexamined. A better and more legitimate “investment chain,” linking savings to investments and in turn to economic growth and wealth accumulation, will increase investment returns, reduce risk, make the system less prone to bubbles and crises, increase trust, and reduce agency costs and related problems. “Sustainability” is key, Urwin said, and in a world of increasing change and complexity, the financial ecosystem — which includes asset owners, businesses, society, and governments — needs to be more adaptive and integrated.
Aswath Damodaran: Successful Investment Philosophies and What it Takes to Make Them Work
During a two-hour discourse, Professor Damodaran reviewed his research and insights on investment philosophies, which he defines as a coherent way of thinking about markets, how they work (and sometimes do not), and the types of mistakes that impact investor behavior. He contrasted an investment philosophy with an investment strategy, which is much narrower and, according to Damodaran, is just a way of putting a philosophy into practice — one that an investor may need to go back to in order to generate new strategies when the old ones no longer work.
Examples of investment philosophies include market timing, growth investing, and value investing. Disciples of the efficient market hypothesis, chartists and technicians, arbitrageurs, and information traders are also adherents of particular investment philosophies, all of which can be categorized into three broad themes: market timing versus asset selection, activist investing versus passive investing, and short-horizon versus long-horizon investing. Central to this framework is whether there is a gap between the intrinsic value of an asset, derived from cash flow growth and its quality, and the market price, which is driven by “noise” relating to fundamentals, market moods, and momentum — and whether the gap will persist or close.
Damodaran discussed the discipline of value investing in depth and argued that there are three types of value investors, as follows:
- Passive Screeners: Ben Graham and Warren Buffett are the high-profile examples. To be successful, they generally need to have a long time horizon and are diversified and wary of tax and transaction costs.
- Contrarians: These investors seek “losers” — firms or assets that most others have given up on. To be successful, these practitioners need self-confidence, trusting and patient clients, and the ability to stomach short-term volatility.
- Activists: These investors focus on poorly managed firms or assets and try to improve operational and financial management or corporate governance. To be successful, they need to have sizable capital, do lots of due diligence, and get to know the firm or asset very well. They must also be able to form coalitions with other investors who are skilled in corporate finance — and be persistent.
Damodaran’s book, Investment Philosophies: Successful Strategies and the Investors Who Made Them Work, now in its second edition, provides additional background on many of the ideas that animated his talk.
Satyajit Das: Investment Strategies for Survival
Das, an author, consultant, and ex-banker who has considerable industry experience to his name — not to mention a cameo appearance in the Academy Award-winning documentary Inside Job — delivered a compelling talk that also addressed the so-called “New Normal” and covered a range of global themes of interest to investors, from the macroeconomic and political situation in Europe and the United States to China and beyond. His key points:
- With growth stalled in Europe, tepid in the United States, and slowing even in emerging economies, we are moving toward the end of growth and the beginning of a period of prolonged economic stagnation.
- The fundamental problems that caused the global financial crisis have not yet been dealt with. Recovery has been based on extending the status quo and pretending that there are no real challenges. Policymakers are seeking growth using cheap money and unconstrained government spending and infrastructure projects that are heavily financed with debt. Debt-based growth has never been sustainable — yet policymakers do not appear to recognize this.
- The world faces a new environment of slow growth and a shift to closed economies, increased distrust of governments and policymakers, and greater financial volatility and social instability.
For more of Das’s perspective, watch this recent video interview on the past, present, and future of India’s economy and capital markets.
Visit the blog of the Indian Association of Investment Professionals for additional insights shared by the conference speakers in Mumbai.
Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.