PIMFA
Addressing structural trends within wealth management portfolios
To generate long-term investment returns and help protect client wealth, it is important to consider structural trends.
By identifying and avoiding the risks that emerge from these structural trends, such as climate change, resource transition, and biodiversity loss, wealth managers can help minimise the impact on client portfolios.
To assist wealth managers in addressing structural trends and emerging risks, Mercer have developed a set of principles. These principles can be considered when setting objectives, constructing portfolios, managing risks, and establishing a governance framework. By following these principles, wealth managers can navigate the challenges and opportunities presented by structural trends.
Structural trends and emerging risks investing principles
- The importance of time horizon is often underappreciated during objective setting, even though it impacts every aspect of the investment process.
Key metrics related to return drivers, risk factors, and correlations should be assessed over the client’s investment time horizon.
2, Wealth managers should integrate structural trends into their broader client risk management process.
The longer the time horizon, the more influential structural trends become, making it essential to build portfolios that can withstand different future scenarios. However, structural trends should not be thought of as solely long-term considerations, as they can manifest in shorter-term periods and have a variety of impacts across multiple timeframes. For example, there may be shorter-term climate regulation risks as well as longer-term physical impact risks.
3, Structural trends should be managed at the total portfolio level.
Risks and opportunities related to structural trends, in particular systemic risks, exist across asset classes and sectors. They should be measured and managed at the total portfolio level, via look-through portfolio analysis and long-term scenario testing.
- Assigning a formal risk budget across a portfolio of long-term thematic investments facilitates a holistic management of the overall exposure.
By assigning a total portfolio risk budget for structural trend-oriented investments and understanding the interaction between those exposures and the broader portfolio, wealth managers can better accommodate the perceived benchmark-relative ‘risk’ associated with these investments.
2. Diversifying exposures across multiple trends will likely deliver more robust outcomes and a lower total portfolio risk contribution.
The future is unknown, so risk may be reduced by spreading exposure across multiple, diversified themes. Furthermore, many long-term structural trends are interconnected, so outcomes may be improved further by targeting strategies that are expected to benefit from or manage the risks of multiple trends at the same time.
3. Many structural trends, such as climate and energy transition, are specialist areas requiring specialist asset management.
Structural trends tend to be highly dynamic – new opportunity sets often emerge, and early disruptors can be disrupted themselves. Specialist managers are best placed to navigate this dynamic. Furthermore, allocations to thematic exposures in broad-based strategies tend to be smaller, and possibly negligible at the total portfolio level.
4.Focus should be on long-term structural trends where they are deemed material and investable.
It is not enough for a trend to be real; it must also be investable – there must be an opportunity to target, or a manageable risk.
5. Performance of long-term oriented strategies should only be assessed over long time periods.
The short-term nature of listed markets means they struggle to value structural trends, which creates opportunities for disciplined, informed investors. Those who seek ‘proof of concept’ in past performance by definition miss out on the returns that may result from a structural shift in conditions.
Contact Sebastian Maciocia, Director of Wealth Management at Mercer, if you would like to discuss these issues further.
Email: sebastian.maciocia@mercer.com
