14 December 2021 
Matt Sisson, Projects and Membership Manager
In an article in 2019 Cazenove's Ben Minter explored the impact of asset allocation and stock selection on portfolio performance. In 2021 he wrote a follow-up article to review the conclusions. Here’s a summary of the key findings and their relevance to University finance teams:
At Cazenove, we believe there are three key areas which will have the greatest impact within University investment portfolios over the next decade: (1) active stock selection, (2) thematic investment and (3) incorporation of Environmental, Social and Governance (ESG) criteria into the selection process.
Active stock selection
While the debate between active and passive will continue to ebb and flow, the potential added value from active stock selection will be useful if market returns are more subdued going forward. Investors in passive strategies can hope to get a similar – but lesser by the fee charged – return to an index (unless the provider is using derivatives or other methods of enhancing the returns). And the good news is that fees for active management have become more competitive.
Furthermore, academic evidence points to concentrated portfolios being the most reliable source of outperformance over the long-term. The excess returns delivered to investors in concentrated equity strategies is highlighted in the table below – which shows the average excess return of active global equity funds over their benchmark, grouped by the number of equity holdings, over each of the past five calendar years.
Source: Schroders, eVestment, February 2021. Excess returns from active global equities funds currently in operation with an AUM greater than $100m.
Thematic investment
The skill in managing investment selection within a portfolio is to be able to identify the themes of the future that are distinct, investable and structural and to avoid those that have reached the “hype” stage. A challenge with thematic investing is that themes often do not have a long track record and some future themes may overlap or lead to style biases in a portfolio.
An example of a current theme is disruption. In the context of the global economy, disruption can be the result of:
A key theme for a number of Universities includes Environmental and Social factors. While we recognise these as critical “themes” more broadly, we think it sensible to incorporate Environmental, Social and Governance (ESG) parameters into all of our investment decisions – recognising the challenges faced by people and planet are not distinct to investment returns.
ESG criteria
A recent paper from the University of Virginia focussed on corporate ESG incidents such as environmental damage, discrimination, occupational health and safety issues, fractious relations with local communities, and anti-competitive practices. There were as many as 80,000 such incidents among listed US companies over the decade 2007-17.
The author finds a clear relationship between the number of past incidents and future financial and stock performance: a portfolio of stocks with high ESG incident rates had lower profits and underperformed the wider market by about 3.5% per year, even when taking into account sector exposure and other risk factors. Furthermore, companies demonstrating higher ESG scores tended to show more resilient performance in downturns.
Our approach
Our investment selection process seeks to identify managers who we think are likely to add active value and who align with our themes and sustainable approach. We diversify across both asset classes and managers to help offset volatility and offer a level of diversification to returns that we believe will benefit our investors over the long-term. We recognise the benefit of integrating ESG considerations into all of our investment processes, using proprietary investment tools to help inform our decision-making.
All of the factors mentioned above, amongst others, will have an impact on future returns for University portfolios. The importance to take advice and partner with a trusted investment manager is paramount. If you would like to speak further about the themes in this article or find out how we can help with your investments, please do get in touch.
The opinions contained herein are those of the author and do not necessarily represent the house view. This document is intended to be for information purposes only. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Information herein is believed to be reliable but Cazenove Capital does not warrant its completeness or accuracy. No responsibility can be accepted for errors of fact or opinion. This does not exclude or restrict any duty or liability that Cazenove Capital has to its customers under the Financial Services and Markets Act 2000 (as amended from time to time) or any other regulatory system. Cazenove Capital is part of the Schroder Group and a trading name of Schroder & Co. Registered Office at 1 London Wall Place, London EC2Y 5AU. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. For your security, communications may be taped and monitored.
