Our industry tends to favour inflation benchmarks, despite their limitations in measuring investment skill. After all, for most clients, a few things matter more than compounding returns in excess of inflation.
What should one expect from a fund benchmarked in this way? For most of my investment career I have believed that such funds should be primarily focused on maintaining sufficient exposure to equities.
This is not an unusual position. The unit trust industry is largely structured around equity exposure, and funds with lower equity allocations typically target lower returns. More than a century of asset class data supports the same conclusion: despite their short-term volatility, equities have been the most reliable way of achieving inflation-beating returns over time.
In that framing, investor aversion to volatility was secondary. If a certain level of return was required, the accompanying volatility had to be accepted. Cold showers are good for you.
However, this framing is starting to come under pressure. As the industry evolves, particularly in postretirement investing, where the balance between growth and capital preservation becomes more immediate, it is no longer clear that a purely equity-centric approach fully reflects investors’ needs. The question is not only what return is delivered but also how that return is experienced.
This has led to a shift in emphasis. Rather than focusing only on the risk of holding insufficient equities, some solutions start from a different point: the risk of underperforming cash while protecting capital. That change in starting point leads to portfolios that look quite different from the traditional approach.
As the industry evolves, particularly in postretirement investing, where the balance between growth and capital preservation becomes more immediate, it is no longer clear that a purely equity-centric approach fully reflects investors’ needs. The question is not only what return is delivered but also how that return is experienced.
These developments are, in part, a response to changing client needs. As a purist, I still find the traditional approach appealing. In another context, I might argue we should all be driving manual station wagons that are efficient, balanced and optimised for performance in the right conditions.
But the car industry did not stand still. The rise of the SUV reflects a response to how people really drive: a preference for versatility, comfort and resilience, even if that comes at the cost of something else.
That does not make the station wagon obsolete. It remains highly effective in the right conditions. But it does suggest that a single design is unlikely to meet all needs.
The same is true in investing. The traditional approach retains clear strengths: simplicity, transparency and a direct link to long-term returns. But newer approaches highlight previously downplayed risks, particularly the possibility that equities may not deliver as they have historically.
Seen in this way, these approaches are not in opposition. They are responding to different aspects of the same problem and can inform each other. Traditional approaches retain their focus on return and compounding, while newer approaches place more discipline on drawdowns and sequencing.
The empirical evidence so far is that investors have been rewarded for taking on equity market risk and that over extended periods equities have outperformed other asset classes.
However, this does not make equity outperformance inevitable. A portfolio built primarily on equities is making a specific assumption that this relationship will continue to hold. Investors may have other legitimate objectives, and an equity-centric approach may fall short in meeting them.
Whatever approach is adopted, it is important to understand what you are buying into and what purpose it is trying to fulfil. Solutions with an explicit focus on capital protection should not be compared directly with more traditional approaches. They are solving for different needs and will perform differently at times.
• Crosoer is chief investment officer at PPS Investments.