The Psychology Behind Better Asset Allocation ft. Aoifinn Devitt

[00:00:09] Aoifinn

Find a way to develop your own voice in this respect, because there will be many jobs you do where no one cares about that voice. And that’s fine, because that is a necessary rite of passage, I’d say. But do develop that voice, because there will come a time when that voice will be needed in terms of you leading a unit, or you having to get on CNBC, or you being asked to do something, and you should be the person that can say yes to that because you have something to say.

[00:00:36] Intro

Imagine spending an hour with the world’s greatest traders. Imagine learning from their experiences, their successes and their failures. Imagine no more welcome to Top Traders Unplugged, the place where you can learn from the best hedge fund managers in the world so you can take your manager due diligence or investment career to the next level.

Before we begin today’s conversation, remember to keep two things in mind, all the discussion we’ll have about investment performance is about the past and past performance does not guarantee or even infer anything about future performance. Also understand that there’s a significant risk of financial loss with all investment strategies and you need to request and understand the specific risks from the investment manager about their product before you make investment decisions. Here’s your host, veteran hedge fund manager Niels Kaastrup-Larsen.

[00:01:32] Niels

Welcome and welcome back to another conversation in our series of episodes that focuses on markets and investing from a global macro perspective. This is a series that I not only find incredibly interesting as well as intellectually challenging, but also very important given where we are in the global economy and the geopolitical cycle.

We want to dig deep into the minds of some of the most prominent experts to help us better understand what this new global macro-driven world may look like. We want to explore their perspectives on a host of game changing issues and hopefully dig out nuances in their work through meaningful conversations.

Please enjoy today’s episode hosted by Alan Dunne.

[00:02:16] Alan

Thanks for the introduction, Niels. Today I’m delighted to be joined by Aoifinn Devitt. Aoifinn is Managing Director of Global Wealth at Monetta.

Monetta is a US$43 billion, US registered investment advisor which provides investment advice to family offices and high-net-worth individuals. Aoifinn has been in the markets many years now, at this stage, an extensive career as a CIO at the public pension side and at the RIA side. Earlier in her career she had her own hedge fund investment advisory business Clontarf Capital and she has her own podcast as well. So Aoifinn, great to have you on today.

[00:02:55] Aoifinn

Thank you very much. Thank you for Inviting me.

[00:02:58] Alan

Not at all. So, you’ll be a pro at this, given your extensive podcasting experience. So, delighted to have the opportunity to chat and give a sense of your background. But we always like to hear how you got interested in economics, markets, and investing in the first place.

[00:03:14] Aoifinn

Yes, well, I actually started out as a lawyer. I studied law at Trinity and loved everything about the old history nature of the case law, loved the writing, just loved the intellectual challenge of that. And I certainly saw myself as having a career in law, but my first entry point into law was as a corporate lawyer in a New York firm.

So, having all of that adjacent work, around the workings and plumbings of commerce and finance, made me very hungry to get to know what that plumbing was all about and actually to make the leap over into finance. So, I spent four years working as a corporate lawyer, two years in New York, two years in Hong Kong.

That really, I think, moved from the zone of using precedence for everything, which was the case in New York. There was always a contract that had been written previously, that you could draw upon, to really being, I’d say, quite entrepreneurial in Asia because there generally was not a precedent for anything. So, there had to be kind of drafting from fundamental bottom-up principles when it came to some of the work I was doing with companies across Indonesia, Singapore, etc.

So, I got really into the coalface of finance then, and that was what prompted me to make the leap, which I did have to do via an MBA. When I say, “have to do”, it was tremendous fun at INSEAD and a very broad and rich experience. And I still have many, many friends from that year.

But I’d say it was easier not to be pigeonholed as a lawyer with legal capability or in house counsel, having done the broader MBA. I started in investment banking and then investment consulting. And that’s how I made my way to the allocator side.

[00:04:49] Alan

Good stuff, as you say. You’ve done the full gamut from investment consulting to hedge fund advisory. And you’ve been, I suppose, on the public side as well as on kind of the high-net-worth. I mean, taking that as maybe the starting point, obviously you’ve built portfolios, done asset allocation for a range of different types of portfolios. I mean, how does that influence how you think about portfolio constructions now in your current role?

[00:05:16] Aoifinn

It’s interesting. When I made the move to private wealth, I expected to be really entering a very different world, a very different set of instruments, set of even language being used. And I will be honest, I had low expectations just in terms of the type of products that would be available, the higher fees that we’d be paying, and perhaps I was expecting to be dumbed down to, a lot of the time, by product providers because that was my experience. There would be one set of materials for the institutional investors and another set for the retail investors or the high-net-worth investors.

My experience was actually quite different. I found that there are many similarities in how institutions and individuals approach the investment puzzle. And there are some key differences as well. Obviously, the taxation consequences for an individual are different. So, we need to look at different paths.

But in terms of portfolio construction, we really start with resilience. You and I both grew up in Ireland, and I’d say in my case, I started in the ‘70s and it was not a flourishing nation at that time. I think we were definitely not a wealthy country. And I think that does affect the psychology with which you approach investing. For me it’s about capital preservation, resilience.

It’s not to the point of having no risk on the portfolio, but it is about having a fairly low tolerance for loss. And having started in the institutional investing arena at Cambridge Associates, that was often charities endowments. Again, perhaps they had a spending policy and they were being well funded from their donors, but they still certainly wanted to be there in perpetuity. So, we have to think about preservation.

In public funds that has always been top of mind, has been preserving this essential fund for beneficiaries down the line. And when it comes to individuals, we’re really speaking about the same thing. It’s about resilience preservation. There may not be the same, say, active need for investment income from a high-net-worth individual. They may have other sources of income. They may not have to run their portfolio for cash flow, necessarily.

That was something we did have to do in many of the public funds that I worked with, and, I think increasingly, public funds will have to do, is have a cash flow component of that portfolio. That’s a little less the case for individual high-net-worth. And equally individuals are often going to have their own proclivities in terms of what they want to invest in or don’t want to invest in.

You may find 80-year-olds who never want to invest in a bond again, or you may find somebody else for whom impact and purpose is at the forefront. So, a very diverse basket, I’d say, of objectives in the work I do now.

[00:07:51] Alan

So, is it fair to say, I mean, we’re seeing the institutionalization of private wealth, or would that be too far to describe it?

[00:07:58] Aoifinn

I’d say to a degree where, if institutionalization means the entering of offerings that have been available to institutions for some time, I think that is certainly the case that’s been grabbing headlines in terms of, say, the progress of private equity, private credit providers into that field. I’d say that is a vexed area that we can discuss in more detail in any way you like. But I’d say the timing is nothing if not awkward, certainly given how some of these strategies are performing just at this time.

We do often not make the same mistakes, but we make different mistakes when we try to open up private markets to a broader set of stakeholders and potential investors. I would suggest there’s some other mistakes being made right now. But in terms of institutionalization, if that means lower, fairer fees, I’d say we’re at the beginnings of that. We’re not at the end yet, but we certainly have seen signs of that.

And in terms of sophistication of that conversation, yes, there is a more sophisticated dialogue happening in private wealth and it’s high time. And that’s a good thing.

[00:09:02] Alan

Absolutely. So, as you say, I mean, we’re at an interesting juncture here, both in terms of the alternative markets and alternative assets and how they’re performing. But I guess more broadly, I mean, you talked about the 1970s, growing up in Ireland. And yeah, as you say, Ireland wasn’t a wealthy place back then, but the world has been through many cycles since then. We’ve Obviously, in the 2000s, we had a global financial crisis. You know, after that, equities have pretty much been one way ever since.

At the same time, you know, since COVID we’ve had the war in Ukraine. We’re now in the midst of another war. It feels like we’re into a new macro regime of greater volatility, more uncertainty. So how does all that come together in your thinking about asset allocation, looking ahead for the next few years?

[00:09:47] Aoifinn

That’s a great question. I’d say, again, getting back to history and how our psychology affects us, I think also we are shaped by our early formative career years. And I spent some of those years in emerging markets on the ground in Indonesia. I’d also, as a student, spent time in Moscow. And at both of those times, I felt it was something about, perhaps a magnetism that I seem to attract chaos in terms of the backdrop at these different places that I went to. There was chaos in Moscow when I was there. There was chaos in Jakarta when I was there.

And what I noticed was, there was always this divergence between the media soundbite around what was happening on the street and what I was seeing happening on the street. So, it was generally less extreme, less sensationalist, less noteworthy, the day-to-day life that I was experiencing. And that dichotomy has always sat with me.

So, essentially it has always convinced me not to necessarily believe the hype, not to believe the extremes, to look for the detail, get on the ground, get the detail. That has informed how I think about many of these market highs, market lows, doomer scenarios, or some of the absolutist beliefs that often are attached to market prognostication.

So yes, how do I translate that into a portfolio context? Well, generally it’s by trying not to be either too concentrated; not to become too thematic in a portfolio; to always maintain the kind of somewhat pedestrian, broad based exposures that are in place; to try to keep emotion out of the execution side; be steady; provide an even keel; and obviously always make sense of the complexity for clients, try to make sense of the complexity.

That’s a lot of what I’ve been doing for 20 years is sitting with investment committees to really help them navigate this maelstrom of complexity jargon and, quite frankly, fearful news flow out there and help them translate that into their portfolio. And whether that’s an individual or a pension fund panel of a public fund, I think there is a need to make sense of this.

In terms of the asset allocation, so, that will clearly dictate quite a diverse, and again, getting back to the formative years, having started at Cambridge Associates, the kind of endowment style portfolio construction approach that rebalances often, that is as well diversified by sector, by cap size, by country, those are really in my DNA.

[00:12:13] Alan

Yeah, fair enough. I mean the endowment approach, endowment style approach, or the Yale model was much lauded for a long time. And I suppose, I don’t know if it’s fair to say it’s coming under more criticism, certainly more scrutiny, as of late, in terms of actually what were the underlying drivers. I mean, there are a few different elements to that. Obviously, having alternatives and private markets was a key component, having an equity bias. And I guess all of that has served people well.

I mean, I suppose from a kind of a high level, do you think that endowment model, that Yale model is still as compelling as it was before?

[00:12:53] Aoifinn

I’d say, as a model in this kind of most base terms, every model deserves scrutiny. And yes, you always need to look at the unintended bets and perhaps the bets that are not being given credit that have been implicit in that, and where the returns have actually come from. I saw this quite acutely during the 2016 Brexit phase in the UK, many of the public funds had a windfall thanks to sterling weakening. That wasn’t due to investment acumen, it was due to simply being in the right currency at the wrong time (arguably, for that currency), the right time for your portfolio. I’d say that it is important to always parse that.

I do believe that diversification, in the endowment style, makes sense when you can tolerate the illiquidity and you have the knowledge, and the connections, and the access to get proper exposure. And those things are all critical. They’re not a given. There are a select few that will have that kind of access and therefore the ability to build a portfolio that genuinely is in the top quartile and can stay there, as opposed to simply kind of a scattershot approach.

So, I wouldn’t say there’s one-size-fits-all. I think we have to be very dynamic in terms of how we think different asset classes are going to evolve. For example, venture capital, private equity, these are clearly evolving. Do you want to be necessarily with the same players it would have been 15, 20 years ago? Doubtful.

So having that kind of open mind, but increasingly, especially as we see the contraction of public markets, there will be, I believe, a need to get exposure to private markets. I am passionate about the need to get money into local projects and to provide spark capital and fuel for some of the innovative ideas that are coming out of university pipelines, for example. And that will all have to be achieved through private means, private plumbing to get there.

[00:14:46] Alan

I mean, you touched on private markets. It’s been a buzzword for a while and private credit in particular. And now, as we’ve come into this year, there has certainly been something of a change of sentiment around private credit. I mean, one thing that struck me is this idea that a lot of private credit had exposure, or still continued to have exposure, to software stocks.

So, I mean, on the one hand, private credit could be positioned as an alternative, even as a diversifier to your equity bucket, but in reality, you’re picking up exposure to kind of high growth equity type exposure. So how diversifying is it? I mean, if you were speaking to a public pension or a board, how would you be explaining how to think about the appropriate role of, say, something like private credit in a portfolio?

[00:15:32] Aoifinn

Well, that’s something I’ve been doing for many years, is using private credit and explaining it. And as I said, it has had a more critical role in some portfolios than others, according to the portfolio’s need for cash flow.

So, you always see credit, private credit, as a diversifier primarily. We would see credit as some form of a deflation hedge in a portfolio, not an inflation hedge which you have elsewhere. It is also a source of income. Importantly, in the case of private credit and that cash flow piece, which you need to offset, really, the total return orientation that a portfolio might have.

We also see it as a way of getting exposure to investment skill, as it’s true that there has been a tremendous amount of skill and alpha generation moving into the private segment, whether that’s on the equity side or the credit side. So, getting exposure to this kind of esoteric strategies as well, whether that be just other contractual based cash flows that are credit, like structured credit, etc. You are getting exposure to that skill piece of the individual that is steering that.

There obviously has to be the same principles applied to any new asset class in terms of diversification, ensuring that the basket is diversified, that you’re diversified by manager that you trust, that you’re in a manager that is taking the right precautions around due diligence, fraud, checks, etc. What we have seen, and I think this is where, again, formative years, having been at Goldman Sachs around 2000 and the kind of bursting of the TMT bubble, seeing a tremendous amount of business plans just go up in smoke in terms of their projections around customer retention, revenue growth, and margin expansion. This really just disintegrated rapidly in the course of days.

So, when you know that a business model can go up in smoke like that, you always have to maintain that skepticism. And it’s interesting because some of that kind of ‘drinking of Kool Aid’ or that ‘hype’ belief we tend to associate with equity and maybe private equity, public equity, we’ve seen it very clearly in the credit side, this type of business model. I’ve seen boutique gym chains being backed with private credit that I know myself were going out of business in my hometown. So, I think there has to be that kind of a reality check with a lot of private credit pieces.

[00:17:42] Alan

Good stuff. I mean, the other big theme that you read about so much in the asset allocation, and particularly the public space, is total portfolio approach and this shift away from strategic asset allocation to TPA and what that might mean. Is that something you’re embracing? Do you think it’s something very different to the old approach? And should investors be trying to emulate TPA, I guess?

[00:18:13] Aoifinn

I suppose if TPA is a different approach, it’s because it’s addressing some of the problems that had arisen in the traditional asset allocation buckets. And those problems shouldn’t have arisen, but they maybe came about because there was a siloed approach happening.

When I worked as CIO at a public fund in Chicago, I was the one and only investment professional on that fund. I was the CIO and I was also the only investment professional. So, you have to, by definition, have a holistic approach when that is the case. There is no siloing, There is no being responsible just for your piece of the portfolio. You always have to think of the portfolio as an orchestra playing together, when the outcome is the goal and all the different instruments have to contribute to getting to that outcome.

So, I would think that a holistic approach is something that any senior allocator should always have had. Whether you call it TPA or not, you always need to be thinking in that way. So, if it had kind of grown into a beast, in terms of asset allocation, that was not led to the wrong set of incentives and the lack of holistic thinking, then reverting to that is intuitive.

I do think it does involve, then, having to restructure, say, incentives and also even how governance works at these institutions. And that, for example, just looking at CalPERS and the changes there right now, the restructuring, a lot of that is brought about by really having to tame, let’s say, the beast, if you call it that, which had developed with a traditional bucket model.

[00:19:40] Alan

Yeah, absolutely. It does sound more like addressing the problems of the past. But at the same time, is there something, do you think, for private wealth or individual investors to learn from the approach? Are there shortcomings in the kind of traditional approach, do you see, in private wealth that can learn something from TPA?

[00:19:59] Aoifinn

I would say I’ve learned a lot from Brian Portnoy, who is the author of Shaping Wealth, and he speaks a lot about what is the goal? The goal is funded contentment. And that’s a very holistic, basic goal that we all have. We want to fund our needs at certain points.

So, if that is the ultimate goal, very few private wealth clients will ever be wondering about their individual buckets. They won’t be obsessed with their bond exposure versus their equity exposure. They are wondering about the ultimate outcome. And, as Brian expresses it very well, am I going to be okay and will I have enough?

I think if we strip it back to that very basic need, and that’s really what we are serving our clients. We are helping them ensure that they have enough and that they’re going to be okay. And that’s why we steer their portfolio through markets as we do. That’s of course a total portfolio approach.

[00:20:48] Alan

I mean, one of the big topics, since we’ve had this move into this decade, and more volatility, and rising rates, has been a change in the correlation between bonds and equities. So, obviously with the 60/40 portfolio, the mainstay of many portfolios and many, kind of, I suppose, multi asset funds are basically a derivative of that 60/40 portfolio.

Obviously, we had inflation in 2021, ‘22 for the first time in a long time, a shift in the bond equity correlation. A lot of people then saying, 60/40 is dead. We need a new model 40/30/30, or whatever it is. What’s your perspective on that?

[00:21:27] Aoifinn

Very interesting developments I suppose. And what I’m actually focusing on right now, when I look at bonds and equities, is I am somewhat perplexed by the ongoing low move index, the load set of volatility in fixed income compared with the increasing volatility we’re seeing in equities, particularly as equities get more concentrated. We would have thought that traditionally bond investors are more of the concerned group and that might have more worry and more concern about say cracks emerging in the consumer confidence, in the consumer demand picture. Meanwhile, public fixed income, we’re seeing this very low spreads, low volatility. So again, what is that saying about the behavior of bonds and equities? Maybe some of the stress in bonds has moved into the private credit arena, as you already mentioned.

So, every set of asset classes needs to be re-thought, and re-analyzed, and re-underwritten, based on the changing macro backdrop as well as the changing investor sentiment and use case. So, I’d say the idea that bonds and equities are always a nice hedge, that probably is yesterday’s news. And it has been so, I’d say, even going back to in the COVID era and in 2022 when we saw both operate in sync again and having catastrophic effects across many portfolios.

So, I’d say we need to think about bonds, as I mentioned before, as a deflation hedge, some ballast, not a great source of income, but some income, but ultimately a diversifier, some risk, some protective effect in a portfolio, but not a great source of return equities, the return engine. But to think about ultimately diversifying that equity exposure so that you have a well-balanced portfolio that is resilient at its core, and all-weather, and firing on all cylinders.

[00:23:06] Alan

Yeah. And I mean, we had this kind of growth of bond alternative strategies, you know, I suppose pre-COVID, when interest rates were very low. And now investors are grappling with that view of, well, what should I have in my portfolio for diversification if bonds are going to be less reliable diversifiers, how do you think about that?

[00:23:24] Aoifinn

Yes, we saw this at the Chicago Police. We did see a lot of those absolute return strategies really hit the skids, let’s say, when really investors should have just been exposed to core fixed income. That would have been ultimately the best place to be, especially as we are in that kind of a downward interest rate cycle.

So, I’d say that where we think about bonds is, be very wary of newfangled innovations when it comes to investing. We think about and I look across all sectors and look at where innovation is prized. And one of my personal interests is looking at psychological safety and how that leads to performance, innovation, etc.

And what I have found is that there really isn’t a great demand for a huge amount of innovation within asset management. And probably rightly so, because we’ve seen so much of this innovation end in tears when it comes to new instruments, leverage, complexity, etc. So, when it comes to bonds, I am quite skeptical of some of the innovation. There’s so little to be extracted, in many cases, through bond trading that, to get too cute about that can be a problem.

Where do you get the diversification in the portfolio, therefore? Well, certainly across equities, there are many ways to get diversification even within an equity portfolio, but that’s for the diversification into other alternatives, real estate, infrastructure, real assets, obviously bonds themselves, but you really get it across the whole portfolio. You don’t rely on just bonds for that.

[00:24:49] Alan

Yeah, I mean, you’ve mentioned the role of bonds as a deflation hedge a couple of times, which is interesting because I haven’t heard much about deflation for a while. Obviously, the last few years we had the inflation spike and then much more, I suppose, concern about that.

But we’ve had, I suppose, a rapid progress on AI and a lot more debate around that. And we had recently this Citrini Report outlining a kind of a doomsday scenario, which was inherently quite a deflationary scenario.

So, do you think this is something that is going to come under radar much more now, from a portfolio construction perspective, thinking about different possible views of the world, that maybe we could see strong disinflationary forces coming back in the years ahead?

[00:25:33] Aoifinn

Yeah, that’s the Interesting. I suppose that the toggle we’ve been doing between the deflationary thesis, which I always trace back to Cathie Wood and her innovation, and the idea that we are seeing this ultimate, this gig economy and how Moore’s law and various other things are occurring in technology that is leading to this deflationary impact.

And, certainly, we were seeing that, in effect, before COVID. And then we’ve had the COVID, we’ve had the tariffs, we’ve had supply chains, demand pull, inflation, all kinds of draws. And it’s very complex, the inflation picture. And I think being able to parse it in a way that is going to give us one path is almost impossible.

I think there will always be these competing forces. Some will come to the fore at different times. I have not been a believer in the thesis that tariffs are not inflationary because what I’ve seen, as the big unknown, is the transmission effect. So, we’ve had tariffs on the one hand, it isn’t a switch that is flipped that ultimately leads to inflation down the line. There are going to be so many ways of cushioning that blow for the consumer until they ultimately have to pay the price that I don’t think we can say that the transmission effect is instant.

So yes, I think we do need to look at both competing forces of inflation and deflation and to build a portfolio that has protections embedded against either scenario.

[00:26:55] Alan

Very good. I mean, we’ve talked about kind of the shifting macro regime. We’ve talked about 60/40. I mean, the other big topic that is put forward as a risk is concentration. We’ve got the US as an unusually large part of the global index. And then within the US, obviously, high concentration with the Mag 7 and the high growth technology stocks.

As you say, often there’s a lot of hysteria about things, but you don’t necessarily get carried away with that. And there are conflicting views on this. On the one hand, people say the last time we saw this kind of concentration it ended badly. But equally, I was reading something that we saw this kind of concentration back in the early 1930s or something, if you had diversified, then it would have been a bad outcome. So how do you think about something that could be a risk but has maybe an economic rationale to it?

[00:27:52] Aoifinn

Again, getting back to the mantra of places I’ve been trained, and Cambridge Associates, it was leverage and concentration. Those were the two big risk factors that were there just through every cycle. And I think people have added other abbreviations to that, but those two are just… And I will always have a structural bias personally against leverage because I’ve seen the dangers of how that can really amplify risk in a portfolio.

And when it comes to concentration, I mean some concentration is… We’ve seen some very successful managers with highly concentrated portfolios.

When it is well managed, when that concentration, going in, has been knowingly undertaken and the due diligence has been done, that is a risk that has been conscious on the part of the portfolio manager.

What is occurring in markets today is that equity markets, particularly US markets, have become so concentrated relative to the rest of the world that any mainstream allocator, say, outside the US, is probably not going to have a portfolio that looks anything like the benchmark that they’re using. The benchmark will be more concentrated if it’s market cap weighted.

So, I think it’s about also questioning whether we’re using the right benchmark and therefore penalizing managers in the wrong way. But when it comes to concentration, I believe that we have not fully underwritten what a current equity portfolio looks like given how we’ve had some extremely fast run ups in market caps of companies such as Nvidia, other members of the Mag 7. The fact that individual stocks like that now dwarf whole country indices is something that is just going to look very different according to how your equity portfolio is made up.

There will be days when individual stocks fall by 10%. We’ve seen them fall by 20% just in the last cycle. And if you have a concentrated exposure to those names, you need to have a stronger stomach, essentially, for that equity portfolio. How do we address that in private wealth? We always dollar cost average into a portfolio. We don’t try to be too tactical by timing markets. We will encourage diversification by cap size, by sector, by geography. That, at least, provides some kind of insulation from that sharp volatility. But we are coaching clients to expect their equity portfolio to look more volatile going forwards but also recognize that there are very few other places that they can be.

[00:30:12] Alan

Okay, interesting. So, it’s not necessarily an argument against passive and, and for active. I mean, for a long time the view being advocated by private investors was don’t look at active managers. The vast majority of active managers underperform and you can get a very strong and well diversified portfolio with a passive index. That mantra still holds do you think?

[00:30:35] Aoifinn

Well, what we would be concerned about passive is that you’re really getting exactly the exposure to this volatility that I mentioned because of the concentration. Essentially passive is going to be replicating the index. So, the concern it fits for…

[00:30:51] Alan

Are you saying just stick with the volatility? I mean, it’s not necessarily a bad thing, but it’s just going to be more volatile?

[00:30:58] Aoifinn

No, we do think it is because the volatility is increasing. We think that needs to be rethought in terms of how equity markets are thought about. That could be a sizing factor. That doesn’t necessarily have to mean you go from passive to active.

I also would share the skepticism around active management’s ability to perform persistently and would suggest that it has become even more difficult to be an active manager today, particularly with this concentration. Again, maybe the benchmark is wrong, but equally, we do need to be even more assiduous about checking and verifying that active managers are in fact earning their fee, at a minimum, and earning their keep, otherwise, in a portfolio. So, we are even more assertive than others in terms of ensuring that active managers have a role. They do have a role, it’s just not everywhere.

[00:31:48] Alan

Yeah, fair enough. I mean you touched on different benchmarks. What about different kind of factors or styles? I mean, without going into the hedge fund side or the alternatives, but even different style approaches, factor approaches in terms of quality, or value, etc. Are they kind of building blocks that you use and think about when building portfolios?

[00:32:12] Aoifinn

I tend to think that those are somewhat artificial building blocks. We’ve seen them come out of the consulting vortex, I suppose, in the US and other consulting framework. And the issue with them is, when you look at a style map, you can see that a label, it needs to be dynamically updated from time to time and that a label no longer applies. So, if it gives some kind of false assurance of having a broad-based factory exposure, you can see that actually managers are kind of closet growth, or where they’re supposed to be value, or their closet mid cap, or they’re supposed to be small cap. So, I think it’s very difficult to put a label on that.

I do believe in having broad-based exposure across those factors, recognizing that individual stocks will move in and out of factor indices. I think it’s critical to have the right benchmark as I mentioned, otherwise we will just have a manager constantly explaining how they diverge or they will either be congratulating themselves for outperforming a non-demanding benchmark if their portfolio actually looks somewhat different.

So, again, some of these labels perhaps need a dusting off and a rethinking or redefining. But having a broad-based exposure, to me, means having broad-based exposure across those factors. That may mean that momentum factors in there for one time. And quality, again, a bit of a controversial topic. And to call anything quality – what is my definition of quality? What is the technical definition of quality?

And again, is that going to be a disappointment if the client is actually looking at a headline index performance and finding that their quality portfolio has really been quite defensive and not particularly exciting.

[00:33:51] Alan

We touched a little bit on public versus private, but I mean, there is this kind of broader debate about the needs for alternative sources of return, whether that’s public versus private or traditional versus alternative. You know, and sometimes these labels can be misconstrued. Something could be private, but it’s not necessarily alternative or it’s not necessarily diversifying. I mean, in terms of how you categorize and label asset classes or think about that, I mean, have you a framework? Is it public, private, is it traditional, non-traditional, alternative? What’s your kind of lens for looking across the asset classes and categorizing them?

[00:34:31] Aoifinn

We do use the traditional categories because that tends to be easiest to understand, it goes into a model, it looks nice in a pie chart. Otherwise, you’d have an infinite number of slices if you were to get down to the minutia. But I’ve always liked the outcome-based approach to investing.

Not so much the risk budget, risk buckets, because again, I think risk is very difficult to define and definitively say this is that risk or this is going to be that risk. I think there are so many, really a matrix of risks, within any investment, so that that can be too artificial.

But in terms of outcome, what is the outcome? Again, this gets to the holistic total portfolio approach. If the outcome is resilience protection, capital protection, if the outcome is inflation participation, if the outcome is income, then you can deliver a portfolio according to those outcomes. So, yes, we would use the traditional buckets, but we will look underneath in terms of where is that source of return and where are we making unintended bets? Where are we actually maybe seeing some correlation that is not otherwise there?

We always think about this propensity for volatility washing. I think it’s been the popular term. The private assets have been seen as being almost insulated from volatility simply because they haven’t been measured at the same timeframe as a public asset. We have to be very skeptical about that.

And I think having been in markets for many cycles, as I’m sure, those of us who’ve gotten to a certain age have been, we have I think already developed that kind of skepticism muscle or that ability to trust but verify when it comes to assertions of portfolio has been untainted by market developments or whatever. So, I think the ability to really dig into that and not necessarily take these assurances at face value, that’s the critical piece of parsing what goes into a private or public portfolio.

[00:36:16] Alan

And is that outcome-based perspective, is that then apply to all of the individual asset classes in the sense that bonds are for income and for deflation protection, equities are for growth and private creditors for some other outcome? Is that how you think about it?

[00:36:31] Aoifinn

That’s at least how they are assigned in terms of outcome. But then, when we actually get to how are they actually behaving, that is a different part of the inquiry. So, we have to continuously re-underwrite or reaffirm that they are delivering that outcome. And we can see this right now with private credit, say, infrastructure, real estate not delivering perhaps the yield that they might have been designed to do. That will, then, necessitate either an increase or a reassignment within those buckets into maybe a distribution asset class or just thinking differently. So, obviously you set it, but you don’t forget it.

[00:37:06] Alan

We’ve seen stronger performance from hedge funds in the last number of years. And I was just at a hedge fund conference, a lot of positivity around the space, people quite optimistic about the growth trajectory. But also, I guess, we’re in a more volatile environment. There is more dispersion, there’s more macro themes, so, in theory, more opportunities. I mean, would you share that perspective or where do you see hedge funds fitting in portfolios?

[00:37:33] Aoifinn

I started my investment career working on hedge funds. So, I always like to say I’ve kind of seen the good, the bad and the ugly. I’ve seen them rise, for around about over 20 years, from being ‘must haves’ in a portfolio to being, I think, the source of some anxiety, pain, portfolio losses. I’d say memories are particularly long when it comes to hedge funds. And maybe it’s that the label has never been shaken, the actual hedge fund label. Maybe that needs to go away and has needed to go away for many, many years.

But because the memories are long, I think you do find, particularly in private wealth, investors that have no interest in hedge fund exposure. Maybe because there was one or two black eyes suffered, whether it’s in the ’07 – the Quant Crash, or there has been an illiquidity event, or a gating of a fund, and then high fees have eroded returns. So, I think that those memories are very long when it comes to individuals.

And when it comes to institutions, similarly, we’ve seen that bucket really go away or be dispersed elsewhere. And even if we look, and say, on the local authority side, and there are nine buckets that will be coming out of their new pooling initiatives, I don’t see hedge funds where they naturally fit there. So, there will be, probably, scattered among whether it’s absolute return funds or some of the private credit allocations.

So, I say, are they coming back? Maybe. I’d say we have to look at them just as skeptically as ever in terms of do they earn their keep, where are the fees, where is there a mismatch between assets and liabilities? Will they deliver the liquidity they profess to? And I’d say there is a higher bar to clear now than ever because of these memories being long, as I mentioned.

[00:39:10] Alan

And when you say the label ‘hedge funds’, is that the idea that they are a hedge or what do you mean by that?

[00:39:15] Aoifinn

Just the entire bucket of hedge funds, if anything, is classified as a hedge fund. An investor will say, well, I don’t invest in hedge funds or I never invested in it, never again since ‘07.

So, I say that type of a strategy, it’s always been a questionable label that it has been really just an underlying who have very different strategies, all of whom have the same legal structure perhaps, same fee structure, but very different exposures.

[00:39:39] Alan

And I mean you’ve worked on the consulting side before and in the US at least, the consultants have been quite strong advocates for hedge fund strategies, for CTA, for macro. I mean, we’ve seen the growth of ideas like risk mitigation strategies. So, having a dedicated sleeve in your portfolio to mitigate risk, I guess for the more extreme outcomes in markets. You’ve had kind of labels: crisis risk, offset, all of this stuff. I mean it sounds like you are somewhat skeptical of that.

[00:40:13] Aoifinn

It’s funny, I haven’t heard about those risk mitigation buckets now for I say probably close to 10 years. So that probably says how long I’ve been in this business. But I always laughed with them is they were really a combination of some treasuries, and some CTA type funds, and there was a lot of cash as well, if I recall. They were quite expensive solutions for what they were underneath.

And then the ultimate question is, did they do what they said on the tin? Did they actually work well, in the case of a risk? And I think the answer was not always. So, they were profoundly disappointing, I’d say, as a general set of offerings. Yes, there were some that were exceptions and I believe some kinds of equity option strategies often rolled up into them.

And so, I’d say yes, I am skeptical of any kind of repackaging of solutions, whether it’s portfolio insurance or anything else. I’ve also seen the same product be marketed under very different labels according to where the zeitgeist was moving, what was the next trendy thing. And again, that has to be a cause for skepticism.

And when it came to say a new asset class like digital assets, bitcoin, on the private wealth side, we were quite slow to ever recommend that. We were providing education, kind of a wait and see approach that might not have been popular with clients who wish to dabble in these. But the reason we could not recommend them was we could not analyze them.

If we don’t know how an asset class like this is likely to perform in different scenarios, we cannot do scenario analysis. This cannot be part of our portfolio that we recommend. So, bitcoin, we’ve seen it move from, is it a diversifier of currency, is it a hedge, or is it just a very high-octane way to get risk on?

[00:41:59] Alan

Yeah, interesting. I mean, the other one that has come back, obviously, is gold. I mean, gold was in competition with bitcoin for a while, it felt like, on that kind of safe haven type asset. Obviously, gold has had a fantastic role for people of late. It’s a great run. And commodities more generally, I guess, have become more interesting.

Obviously, you’ve been in the market through the full cycles. You’ll remember when commodities didn’t appear in portfolios, then they did, then they didn’t, and now they’re coming back. So, gold and commodities, are they back as core allocations again, do you think?

[00:42:35] Aoifinn

Again, that’s the beauty of having many cycles. You have the same conversation of history not repeating but rhyming. And we’ve had this conversation 10 years ago, perhaps, about the use of commodities, 20 years ago about the use of institutions and commodities. A couple of core truths have applied the entire time. One is that holding the physical is complicated, expensive, and not for everyone.

And second is this idea of the divorce perhaps between the underlying commodity prices and some of the stocks or the products that are tied to that. Sometimes there is a complete hand in hand correlation, other times there’s a real dispersion and you don’t know what you’re necessarily getting.

I think the idea of this being the inflation hedge has been a complex assertion. There has been, maybe, a steady state inflation hedge, normal inflationary times. There has been reasonable participation when it comes to the shock inflation, it hasn’t protected that well. So, I think that that’s another.

And now gold, looking at the different factors driving gold, whether that’s the technical factors, the Chinese retail buyer at the margin, central banks around the world, whether it’s the concern around fiscal budget deficits and concern about that, that I’d say, that thesis for buying gold is a way to hedge the rest of the portfolio.

But again, I suggest it is not done. It is done in a moderate way, that something like that is not more than 5% of a portfolio, that it is done in a diversified basket approach as opposed to the metal itself. And then when we go outside gold, that is in itself volatile, but also something like silver is far more volatile as we can see from the movements.

This defining year for metals, last year, well, it was really defined the beginning of this year by just how volatile those metals were. So again, I bet, knowing what you buy and knowing what you’re getting into in terms of volatility, that’s where that would…

I think I’m quite comfortable owning, say, an equity manager that owns and some managers do this as part of their way to create a resilient, well diversified portfolio. But actual naked exposure to a commodity like that I think is probably too problematic for most investors.

[00:44:44] Alan

You’ve touched on kind of the long-term cycles, how they rhyme at times, how not, how we have these long-term trajectories for different asset classes and how, I guess, sentiment shifts over time as well. And even the regulators can, at times, on the pension side, encourage everybody into bonds. And it felt like that was of low yields. Now, the current thing is the UK encouraging people into private markets. In the US you have democratization of alts, and you wonder is this the right time for that as well?

I’m also conscious that we’ve both been in markets for the same kind of period, three, three and a half decades. It’s been the globalized world of equity markets. Okay, we’ve had bear markets, but, by and large, it’s been a very favorable period that has gone on and on, and the last 15 years has been very favorable indeed. I mean, do you worry about that we could see a period, at some point, which seems hard to imagine, like a 15, 20 year period like 1966-82 or even the Depression?

People look at history for these episodes and think that they are just things that happen in the past, won’t be repeated. But as part of your portfolio construction process, when you’re thinking about resilience, when you’re thinking about all of that, how do you kind of balance that kind of perspective of staying grounded, don’t overreact to the hype, but at the same time keep this risk in your mind that things might get bad beyond our expectations at some point?

[00:46:23] Aoifinn

So, I firmly believe we need to look at the macro backdrop. We need to pay attention to the factors that are affecting the managers where we work. In terms of looking at recent, what are the key drivers of many market actors? We know that greed is a huge part of that. Looking at some of the behavioral biases that we actually think about are more relevant for individual clients sometimes, are actually very relevant at an institutional level because these behavioral biases are affecting the market actors.

So, when we think about, as I said, greed, the incentives, the idea of recency bias – this bias that this can never happen to me, these are all the behavioral flaws that the financial actors, I think, are going to be riddled by. And we can see this in the recent book, 1929, where the focus was not only on the actors behind the crash, but also on their own kind of personality foibles, their insecurities, their desire. And we’ve seen this again in some of the political scandals, sort of embroiled many of the financial actors. These are driven by the desire to feel valued, the desire to feel that you belong.

So, this is a little bit of a profound deviation into behavioral style, which I think is why we have to be very alert to being told what we want to hear as investors, because we are essentially being given a false assurance. So, if we can detect these false assurances, as investors, and be very alert to that, I think that’s how we can let our portfolios operate without that degree of hype.

As to whether I am concerned about a portfolio hitting a very, very rough, bad patch, I don’t believe we’re headed to a big kind of 1929 type depression style. I think we have now not only enough diversity in the underlying assets and asset classes we can invest in that there will be a way to generate some income with all of that. We know our portfolios are not all stacked on black. And, equally then, just in terms of the backdrop in which we operate, we know now, since the last crisis, that we have institutions that are ready, armed, and able to step in as shock absorbers and cushion those blows.

So, I’m not confident that we will essentially avoid all damage and all market downturns, but I do believe that we have more of an orchestration behind the scenes to ensure that we don’t hit something really devastating.

Now, in terms of the Citrini Research, to bring that up, in terms of whether there could be that kind of a dystopian development, again, I’m not a believer in extremes and not a believer in doom cycles or in extreme positive or extreme negative. I think, actually, the hundreds of podcasts I’ve sat on the other side of the mic have really instilled that in me. Is just that real diversity of human experience, the diversity of highs and lows, the fact that they happen to everyone. That type of a normalization of a life, that is made up of highs and lows, has led me to be a lot more middle of the road, I suppose, in terms of how I see outcomes. And that’s why a portfolio, I just tend not to get carried away.

[00:49:27] Alan

Yeah, fair enough. I mean, you touched on kind of behavioral challenges. You touched on kind of how various assets and strategies are represented and misrepresented. And obviously, if you’re building portfolios, the asset allocation is only one part of the equation. Then you have to either buy securities or allocate to external managers.

And I know you had your own advisory business, earlier in your career, focused on manager selection, manager analysis. I mean, what do you think are the key, you know, challenges, behavioral challenges, I guess, when it comes to selecting external managers?

[00:50:04] Aoifinn

Clearly, one has to look at all the usual metrics in terms of performance and analyze that. The key behavioral challenge with the manager is that one falls in love with the manager, metaphorically speaking, and doesn’t want to… it’s difficult to fire that manager. And that is, I think we know, well reported, is that it’s easy, the hiring. It’s the actual termination that is the challenging piece.

Whether that’s a desire or not to crystallize a loss, or to admit you were wrong, or just to have that conflict because there is some conflict inherent in a termination discussion. I’d say that that is a muscle that you build over time. And I think it’s never easy. No one ever likes to be that manager.

But equally, if there is better dialogue from that manager from the outset, hopefully it won’t come as such a shock if these kind of things are not cliff edge type divestitures, but they really are telegraphed well over time. So, I say that is the one behavioral side.

And another thing is just not necessarily doing that piggybacking, which is, again, another dangerous behavioral thing, is believing that some other peer of yours has done the due diligence for you. When I started my consulting career, it was around about the time of Madoff, and actually I was the beneficiary of some quite broken, damaged portfolios that had been damaged by exposure to Madoff. And we were then charged with rehabilitating that.

So, I suppose, in a kind of odd way, it became a winning strategy for me to kind of swoop in and help to repair portfolios. But clearly, the Madoff’s problem was a piggybacking problem. It was a slipshod due diligence on the part of allocators. And that kind of slipshod due diligence is happening everywhere, not just by allocators, but particularly in the private credit sector. And that’s where we’re seeing the cockroaches emerge, as we’re seeing.

[00:51:50] Alan

Yeah, interesting. I mean, it feels like the due diligence processes, the RFPs, they’ve become lengthier and lengthier, but at the same time, is it just… People still make errors or things get through. Is it just people ticking boxes, or processes are too rigid, or how do you kind of reconcile what seems to be even lengthier due diligence processes, but maybe delivering less true insight?

[00:52:19] Aoifinn

It’s interesting. It’s maybe because I studied as a lawyer, but we in law, you have a case law, you’ll always have the case note at the beginning, which will kind of shorten kind of the executive summary. Tell me what the bottom line is up front. Tell me what I need to know. And that has been, always, my preferred approach to communication.

I have an aversion to data dumps which are perhaps decided to maybe provide security or to provide cover for recommendations, but ultimately tell us nothing at all. I also have an aversion to macro analysis that is kind of theoretical and academic in nature and has no actual relation to the portfolio.

I always ask the question, well, so what? You’ve told me all this, so what does that mean for my portfolio? Do I have too much US dollar exposure? Should I reduce that? Do I need to pivot towards more income, towards more inflation protection? This is the ‘so what’ that needs to be done. So, when it comes to due diligence, RFPs, I agree, I think that is getting completely out of control. Just as board packs equally have gotten out of control and taken on a life of their own as they reach the hundreds of pages. Ultimately this is now, with AI, probably going to get even worse. AI is generating the RFPs. AI is probably reading the RFPs.

So, we’re going to be in this loop of boilerplate to boilerplate, algorithm to algorithm, with no actual human in the loop, suggesting that maybe this is not exactly what I need to know. What I used to do at Chicago Police, as CIO, is I would create the RFPs with kind of, I wouldn’t say they’re Easter eggs hidden, but they were at least questions in the RFP that was very specific to our own situation because we had a fairly unique situation with a very low funding, poor cash flow situation there. I would say, well, how can we… Looking at the rest of our portfolio, why does your solution fit this in particular?

And that I think was kind of a great way for me to separate wheat from chaff, because so few RFPs ever answered that question. Or if they did answer it, it was answered with more boilerplate. So, just a that little bit of effort upfront to actually address the client’s actual problem, I think is probably just a little bit of a hint as to how to get through that process. But equally, and this is an issue for finding a job, it’s an issue for finding a manager, the problem now with volume and with sifting through the volume. How is that going to be circumvented? Through building networks and cultivating that network.

If you’re a manager with an allocator, way before you know what that allocator needs, and really being sensitive to solving that allocator’s problem, making their life easier, making their job easier, and getting them to where they need to get to.

[00:54:51] Alan

Just before we wrap up and get towards the end, I wanted to get your perspective on kind of decision-making processes because I know you mentioned being the sole investment person in your own in Chicago, which makes things quite easy in some senses. There’s no endless, I guess, debate and committees.

But equally you’ve been part of much bigger organizations and now, I guess, you observe how individual investors as well, or family offices and make decisions. I mean, what’s the best optimal investment process, do you think, that harnesses collective wisdom, but kind of doesn’t allow for a kind of group think?

[00:55:32] Aoifinn

I suppose I would come back to investment committee construction and pension fund committee construction when it comes to decision making because that ultimately, if you have a well diversified, well trained committee, that will hopefully avoid groupthink in that case. I do think, when it comes to investment teams, having teams that have cycled through different areas and are not necessarily wedded to their own.

I think lateral thinking is a great skill. That is where we will ultimately overcome the machines is with our ability to draw connections, to be creative. That’s again, something that law really teaches you because you’re applying case law in a different but analogous situation. So, you’re not necessarily getting exactly the same set of facts. So, the ability, and this gets to, again, looking beneath the hood of strategies and finding, well, what is really driving that strategy. That is a form of lateral thinking because you may have to combine two disciplines in getting to the root of that.

So, that decision making is key. Having the tools I mentioned before, around the ability to verify, to test your decisions. Somebody I love, who does this, Mark Steed. He’s the CIO at the Arizona Public Fund Employees Scheme. He’s been there for many years. He is a great, innovative thinker when it comes to getting his team to learn how to be better forecasters because he actually gathers, collates their forecasts, and then will go back to them at the end of a period with the outcomes and get them to verify whether those forecasts came to bed. I think that is the kind of training of that muscle so that we ensure that we become better risk takers, better forecasters.

[00:57:05] Alan

Very good. Well, we always like to ask our guests, before we wrap up, about their, I suppose, advice for people coming into investing and into the markets. Obviously, you had a background in law before you moved into doing an MBA and then into markets, which by all accounts, listening to you today, it feels like you feel the benefit of it. But if you were to kind of advise people who are starting off in their careers about things to do, things to read, what would it be?

[00:57:35] Aoifinn

Well, first of all, don’t overlook just how absolutely fascinating this field is. It is always changing. It is affecting our lives day to day, the prices we pay, the taxes we pay, and affecting the worries that we bear when we think about the current geopolitical scene. This is exercising every aspect of our life, and finance touches all of this. So, I’d say, you know, first of all, realize what you’re missing if you don’t know about it. And I think I didn’t know about it as a law student. It didn’t touch my life. It only entered my life when I started working in the corporate law field.

So, anyone who’s already kind of got onto that bandwagon and realized how interesting it is… I’d say keep reading, keep creating. And if you can’t find a way to express yourself, find a way. Start a blog. Start a video platform. Find a way to develop your own voice in this respect, because there will be many jobs you do where no one cares about that voice. And that’s fine because that is a necessary rite of passage, I’d say, in finance to go through the hoops of learning the skills and being an apprentice, learning from elsewhere.

But do develop that voice too, because there will come a time when that voice will be needed in terms of you leading a unit, or you having to get on CNBC, or you being asked to do something, and you should be the person that can say yes to that because you have something to say.

[00:58:57] Alan

Very good. Well, you mentioned CNBC. I know you appear there from time to time so people can follow your work at Monetta and I guess on CNBC. And obviously you have your own 50 Faces podcast as well. So, Aoifinn, thanks very much for coming on today. It’s been great speaking to you and from all of us here at Top Traders Unplugged, stay tuned for more content. We’ll be back soon.

[00:59:22] Ending

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