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This year marks the 20th anniversary of Opportunistic Investment, a Wellington suite of strategies that aims to give clients exposure to the firm’s best, unconstrained multi-asset ideas. The strategies are overseen by Brian Garvey, a seasoned portfolio manager who seeks to identify — and capitalize on — contrarian investment opportunities that arise from global imbalances and long-term structural trends.
Much has changed since this team began investing in 2000. Back then, flip phones were commonplace, Bill Clinton was still president, and opportunistic investing was in its infancy. Over the next two decades, we saw profound changes in technology and geopolitics, new approaches to asset allocation, and more than a few major market drawdowns.
Brian recently discussed some of the team’s key takeaways from 20 years of opportunistic and thematic investing.
1. The best ideas come from clients.
Innovation can come from simply listening to your clients, as the problems they’re asking you to solve are likely shared by many others. This best describes the origin of the team back in 2000. It grew directly out of a request from a client who wanted to exploit opportunities outside of traditional benchmarks, but faced challenges doing so given the time demands and research breadth that were required. Identifying investable themes, conducting manager due diligence, and getting board approval for allocations to often-unfamiliar investments worked against nimble implementation. Our client decided that a team dedicated to providing timely, flexible exposure to high-conviction investment ideas was a better approach.
Opportunistic Investment became the client’s solution and effectively played the dual roles of return enhancer and diversifier, giving them exposure to new market segments, specialty strategies, and Wellington’s best investment thinking. That’s exactly what we offer clients today, so I feel we’ve stayed true to our original mission. While our investment universe has been in constant flux, our philosophy and process have remained consistent for 20 years. By my definition, opportunistic investing should adapt to the changing environment and shifting opportunity sets and be able to take advantage of market dislocations. During the first half of 2020, for example, we saw significant market volatility caused by the COVID-19-driven global recession, which led the team to uncover and invest in a number of emerging trends.
2. Every decade is different.
If our team has a motto, it’s that “every decade is different.” Investors tend to be psychologically anchored to the past, often expecting recent return patterns to predict performance going forward. But what works in one decade is often the polar opposite of what worked in the previous decade. The roaring 1920s were followed by the Great Depression of the 1930s, the Nifty Fifty of the 1960s turned to stagflation in the 1970s, and the tech bubble of the 1990s was replaced by the commodity super cycle in the 2000s. History suggests that the worst strategic asset allocation decision is to extrapolate the dominant trends of the past decade.
We believe each economic business cycle has a unique structural footprint that creates truly singular, noncore investment opportunities. Such opportunities are typically amplified by negative investor biases. When investors experience a long period of frustration with one area of the market, unwinding that negative sentiment can take time. But once sentiment begins to improve, it can reinforce positive fundamental change and help launch long-term bull markets. The ideal investment for us has these characteristics:
- It has suffered a long period — perhaps 10 or 20 years — of chronic underperformance, or even dreadful performance;
- The underperformance ensures that most investors have developed a mental bias against the investment, making them unwilling to commit capital to it; and
- Then the team identifies a catalyst for structural change that reverses the negative fundamentals plaguing this “perpetually underperforming” investment.
The 2010s was a decade marked by secular stagnation, as investors sought out stable growth — companies with reliable earnings that weren’t affected much by a subpar economic cycle. If open-ended fiscal policy backstopped by central banks can ultimately end secular stagnation, it will likely usher in new market sector leadership. Such an investment environment may be more conducive to opportunistic and rotational asset allocation strategies.
3. Alpha is a function of the breadth of the opportunity set.
Alpha generation from investment specialization has become more difficult in the age of big data and artificial intelligence. In our experience, the broader one’s investment universe, the greater the potential to generate alpha. Expanding one’s universe means casting a wide net beyond just traditional asset classes to include less efficient, often niche markets that may be under-researched and poorly understood, which can make it easier to find (and capture) mispriced opportunities. Our retired teammate Mark Lynch used the analogy of a “connect-the-dots” game, where each day in the financial markets gives us another “dot” or new piece of information. The investor who connects the dots most quickly generates the most alpha. I think taking a macro-level view of markets enables us to connect dots that specialists may not see, such as impacts across different sectors or asset classes.
Additional opportunities may be found in “dislocated,” out-of-favor assets from which many investors have fled — for instance, European sovereign bonds following the 2011 debt crisis or gold-mining stocks in the late 2010s. In both cases, apathy in the investment community led to relatively cheap valuations and multiyear total-return opportunities.
That’s why our team members are empowered to think outside the box and pursue nonmainstream ideas. It’s also why we follow an unconstrained, benchmark-agnostic investment approach. The goal is to outperform core markets, while also providing diversification benefits.
4. Portfolio construction is a forgotten art.
The last point on seeking diversification benefits, while also enhancing return potential, is critical. It ties in with the art of portfolio construction, which we believe has fallen by the wayside as many investment managers have strayed from fundamental-based investing amid a multi-asset universe that has been continually trying to reinvent itself over the past 20 years. In our view, optimal portfolio construction begins with a recognition that most risk arises from top-down decisions, not from bottom-up security selection. And a well-built portfolio has several layers of diversification embedded in its structure — multiple asset types with different return drivers, as well as varying time horizons, geographies, investment styles, and objectives. For example, our approach to opportunistic investing combines the long-term thematic ideas we’ve identified with higher-frequency, market-neutral strategies, and tactical positions.
The interplay of these three components leads to an “all-weather” portfolio that we believe can outperform broad markets, while reducing correlations to traditional assets. In our view, an important advantage of this three-component system is that it naturally builds diversification into the structure of the portfolio. In other words, downside risk mitigation is embedded in a robust portfolio-construction process, thereby minimizing the need for “on-the-fly” risk management. Drawdowns can be draining from both a time and a psychological perspective, so the less time we can spend in “drawdown mode,” the more time we have for thematic research to identify the next asymmetric return opportunity.
5. Your best risk-management tool is your imagination.
Some risks are not measurable. In fact, rigorously measuring investment risk can be dangerous in itself because it may lead you to overly focus on what’s quantifiable, when the major risk event in each cycle tends to be fundamentally unique — it’s always different next time — and outside the scope of the historical data on which the risk analysis relies. Unfortunately, risk systems are always finely tuned to fight the last battle. That’s why the greatest risk may be a failure of imagination. We would argue that being able to imagine the impossible is, in some ways, the main core strength of a successful contrarian investor. Accordingly, we’ve developed a multipronged risk-management system designed to spur our collective imagination — one that incorporates numerous models and look-back periods; factor- and return-based methods; stress-testing using a variety of scenarios; and the ability to compare high- and low-volatility periods. Our opportunity set is unconstrained, but the portfolio’s volatility profile is not.
Alpha — both positive and negative — is about surprises; otherwise, it would be efficiently incorporated into market prices. The logical next question is, how can an investor become better at anticipating surprises? I think the key is to have a wide network of information and opinions to help foster cross-pollination of views. Thankfully, given Wellington’s varied portfolio management styles and investment approaches, it is easy to connect with other investors who may either validate our investment thesis or offer an alternative viewpoint.
I’d add that portfolio liquidity pairs well with risk analysis and risk management. In addition to understanding portfolio risks, we also need to be able to act when adverse market events happen. Throughout its 20-year history, our team has prided itself on being nimble during periods of market dislocations, enabling us to identify asymmetric return opportunities in niche, potentially misunderstood assets that are generally not widely owned elsewhere in client portfolios.
6. Choose your time horizon wisely.
Another lesson we’ve learned over the years is that you can’t maximize short-term performance without having a long-term investment perspective. Conversely, you can’t maximize long-term performance without seeking to profit from short-term volatility. It’s better to be: 1) very short term, extremely high turnover, and quantitative/systematic; or 2) very long term and fundamental/discretionary; or 3) both. Perhaps the toughest way to generate alpha is to be stuck in the middle between these two time horizons, as that is where most market participants find themselves.
In our judgment, it’s best to be very long-term-focused, while tactically managing exposures to high-conviction themes in order to take advantage of market volatility. Investing in long-term structural themes requires the ability to endure temporary bouts of volatility and underperformance, but if history is any guide, such patience through the more trying periods is often rewarded when the tide eventually turns. Our goal is to build a portfolio from initially out-of-favor sectors and hold for the long term, allowing structural changes to turn contrarian investments into consensus ideas.
We believe this is particularly pertinent at a time when opportunistic asset allocation strategies may be poised to outperform, given the current low return expectations from core investment areas. Typically, business downturns serve to “wipe the slate clean” and lead to new investment and consumption patterns that can structurally change what market themes are in place. With this in mind, we have recently introduced several new themes in our portfolios and expanded the scope of others to increase exposure to areas we believe will lead the way in the next business cycle.
7. Bring an open mind and passion to your craft.
When allocating to investment managers at Wellington, the most important question I ask myself is whether the particular approach is the vision of the person managing it. Our most successful allocations have been cases where the portfolio was an extension of the portfolio manager, who was essentially betting his/her career on the new strategy. We tend to get less excited about a product conceived by a committee.
We also seek out portfolio managers who think about markets differently than we do, because they tend to offer complementary alpha streams in the overall strategy. They may trade over a different time horizon than ours, in a different investment style, or focus on a sector that we typically do not traffic in.
8. Unconstrained investors must be intellectually curious
Finally, we believe curiosity is the one characteristic that best defines our team as a whole and every individual team member. Global financial markets are fascinating and unpredictable, and an insatiable curiosity is needed to uncover promising new trends or spot outliers in an ever-evolving investment landscape. Curiosity drives innovation and new perspectives. It’s also the trait that has helped us to deliver competitive results for our clients over the past 20 years. And I’m confident that the next 20 years will be just as successful.