The impetus for refreshing an investment strategy

To the point

• Canadian investment leaders face factors driving the need to reassess their investment strategy:

- Uncertain external environment: Geopolitical risks, inflation, market volatility.

- New stakeholder expectations: Expanding beyond financial performance to ESG considerations.

- Pressure on private markets: Intense competition, rising interest rates.

• Chief investment officer’s (CIO) must be nimble and consider market outlook to adapt portfolios and meet clients' needs.

• Three critical components of a winning strategy:

- Foundational decisions on investment targets and ideology

- Allocation choices and investment styles (where and how to invest)

- Capabilities and management systems

• The capability and management systems required to execute on the investment strategy will be pervasive across the enterprise, and establishing alignment with the technology, data, and operating strategies are critical to success

As the markets shift to a higher probability period of market dislocation, chief investment officers (CIOs) must be well-equipped to navigate these changes. With alpha generation becoming increasingly challenging, and client and member expectations influencing investment decisions, it is crucial for CIOs to articulate a robust investment strategy that can withstand external pressures and deliver persistent returns. While this may seem daunting, we believe that a winning investment strategy, rooted in a firm's comparative advantage and investment ideology, and supported by robust capabilities and management systems, will help the firm navigate through the unpredictable and evolving market conditions.

In today’s rapidly evolving market landscape, Canadian investment leaders face a multitude of factors that drive the need to reassess their organization’s investment strategy.

Uncertain external environment: Emerging geopolitical risks, heightened inflationary pressures, increased market volatility and an uncertain market outlook have prompted investment leaders to re-evaluate their strategic allocation and risk exposures.

New expectations among stakeholders: Clients and members’ expectations are expanding beyond just financial performance. For example, given increased societal focus on ESG, many have been turning to their investment managers to ensure investments reflect this preference.

Emerging pressure on private markets: In Canada, private assets under management (AUM) saw incredible growth between 2020 and 2022, increasing from $188.4 billion to $322.6 billion.[1] This points to a heightened competitiveness between firms for deals in real estate, infrastructure, private equity, private debt, and other alternative asset classes. The challenge is compounded by the headwind of rising interest rates, that add leverage costs and tighten the share of available credit.

Chief investment officer’s (CIO) must be nimble in their response to build portfolio resiliency and address the needs of clients/members. CIOs need to consider the current market outlook across both public and private assets and define comprehensive investment strategies to remain nimble in adapting to market fluctuations, reinforce their competitive edge, mitigate investment risk, and generate alpha, all the while addressing the preferences of their clients/members.

For pension plans in particular, the accuracy and implementation of these adaptations are crucial to balance risk, maintain investment returns, and ultimately meet their pension obligations. In response, we are seeing Canadian pension managers adapting their target allocations to account for these new market conditions (see figure 1, from the 2023 Deloitte Global CIO Survey).

Breaking down a thorough strategy

At its core, a successful investment strategy must be cohesive and all-encompassing, accounting for specific aspects of the market landscape and client needs. Our framework outlines what we consider to be the three critical components of a winning strategy (see figure 2)

1. foundational decisions surrounding investment targets and thesis,
2. choices about where and how to invest
3. capabilities and management systems
   

As depicted in figure 2, a comprehensive investment strategy requires a strong bedrock of firm-held investment targets, ideology, and comparative advantages, informed by both their unique perspective on the market landscape and articulated client/member preferences. By establishing this steady foundation, a firm will be better positioned to optimize its investment outcomes and position its North Star, which will inform future strategic decisions.

In the next tier of our framework, investment managers must decide where and how to allocate funds to best achieve the firm’s investment objectives, align with its investment beliefs, and make use of its comparative advantages. These key decisions include how to allocate capital across market segments, geographic regions, and asset classes—considering both firm-wide and specific asset-class goals—and examining investment styles (e.g., thematic) and partnership approaches, among other factors.

Finally, an effective investment strategy should identify the capabilities and management systems a firm must build or refine to best support its investment decisions and optimize its comparative advantages. Examples include establishing a private equity arm, redesigning incentive structures, and standing up a relationship management team.

From design to reality 

With structural and investment choices established, investment managers can then adjust their existing portfolio, both in terms of allocation and new holdings/asset classes, to meet the objectives set out in their investment strategy. For this process, we recommend a dial-up/dial-down approach, in which investment managers define the specific investment (dial-up) and divestment (dial down) changes required across a given portfolio to achieve target state holdings. This dial-up/dial-down strategy is represented in figure 1 through the allocation shifts that Canadian investment managers intend to make within the next year.

To implement and operate a target state investment strategy successfully, required capabilities and management systems must first be established, with specific asset types necessitating distinct sets of capabilities and systems. For example, when considering investing in private equity assets, an investment manager might first develop co-investment channels with existing partners that partake in private equity investments (i.e., the capability) and establish an organizational structure for its new private equity arm (i.e., the management system). 

The following are several critical initiatives that can provide the necessary foundations to support a comprehensive investment strategy: 

• Data and technology modernization: This involves modernizing the existing investment technology stack and data platforms to provide enhanced investor decision making capabilities for the front-office (e.g., self-serve access to high quality data & analytics) and streamline the existing middle- and back-office functions (e.g., increased straight through processing).
• Preferred partner program: This initiative aims to define an approach to building relationships with external parties to get preferred access to new investment opportunities (e.g., stock issuances, bond issuances, new alternative assets), secure required funding for an investment, gain understanding of technology or concepts, and more. This approach can include establishing tailored relationship-tracking technologies and management systems, with an overall aim of better defining and maintaining important external relationships.
• Operating model design: A streamlined model helps ensure optimal structure across asset classes, regions, and industries to offer scalable investment coverage. It also allows teams to better collaborate and tap into the broad expertise of members.
• Mandate oversight process: This involves defining a robust process to oversee and monitor the performance of specific investments (e.g., asset classes) and external managers to enable nimble and swift adjustments to individual holdings and overall strategy.
• ESG considerations: These involve adjusting existing investment processes to help ensure ESG metrics are properly considered when assessing new and current investments as well as incorporating ESG metrics as measured KPIs throughout the investment selection and monitoring process.
  

Key factors for execution

Firms can improve their chances of a successful investment strategy refresh by addressing common challenges in both the design and planning phases, and the rollout stages. Methods include incorporating regulatory considerations into strategy design and decision-making, such as by considering the effects of changes in asset allocations and approaches, proactively managing internal and external stakeholder expectations, and working to ensure effective change management is in place to support new and existing talent.

It is also critical for firms to keep their investment strategies current, while enabling nimble decision-making in the face of market volatility and changing external factors. Firms should ensure to consider the role of data management and technology as part of the strategy, including integrated systems and data integration, to allow for rapid decision-making and effective adaptation of the strategy.

Conclusion

A successful investment strategy requires a cohesive and collaborative approach that accounts for the specific aspects of client / members needs, the firm’s investment beliefs, and the market dynamics. A winning strategy will capture the firm’s specific foundational investment targets and thesis, outline the specific choices on where and how the firm will allocate capital, and finally define the capabilities and management systems enabling the strategy. The deliberate identification and design of the capabilities will help ensure the correct management systems are in place to allow the firm to successfully meet the objectives set out in the strategy.

Ultimately, a comprehensive investment strategy coupled with a well-planned, intentional approach for its execution can position investment managers for success in the evolving, increasingly competitive and complex market landscape.

Special thank you to Alex Whang, Agnes Wang, Steven Nader, Noah Folkins, Sangeetha Subramanyam and Rachit Shankar for their contribution to this article.