Total time: 25:36
0:04
Roman: Welcome to the Sage Advisory podcast. My name is Roman Samuels. I am one of the regional consultants here at Sage Advisory. We are here in beautiful Austin, Texas, which is the headquarters of Sage Advisory. And today I'm going to be sitting down with our Vice President of Research Komson Silapachai. In today's episode, we are discussing what is the best approach to getting your client to where they want to go in their investment journey: strategic asset allocation or tactical asset allocation.
Roman: You know, I've worked with you for a number of years now, and we've worked in the trenches together and I'm sure you've been out in the field, you've met a lot of advisors, but for anybody listening who hasn’t met you, tell me about your investment journey. How did you start in this business, you know, how did you get to Sage? What did that journey look like?
0:55
Komson: Yeah, so, just starting at the very beginning.
Roman: Let's go there.
Komson: I was born in Bangkok, Thailand, so you know, I lived there until I was seven. And then I moved here to Texas. I consider myself a Texan. I grew up in the Dallas area. And then for college, I went to Texas A&M. So I'm a proud Aggie living in Austin, behind enemy lines. But, you know, no one has seemed to treat me badly due to that.
Roman: Yeah, we love you, man.
Komson: No, it's been great. And so, you know, after college, I worked for the Teacher Retirement System of Texas.
Roman: You studied finance in college?
Komson: Yes, I did. I did. And I started there, pretty interestingly, I started there in February 2008. So I started my career, two weeks later, Bear Stearns collapses. Well, you know, at Texas teachers it was pretty interesting because you're invested across everything globally. I really got to see the full sweep of the crisis. And I was in the asset allocation group at the time. Over the next eight years I worked in a lot of different groups. So I was in trading, I traded equities, fixed income. And then lastly, I was in the asset allocation group focusing on, mainly on managing the fixed income portfolio, but also larger asset allocation issues. Like strategic asset allocation.
Roman: Okay. And this was for the Texas Teachers’ pension fund? If I'm not mistaken, that's a pretty big fund.
Komson: Yes, it is, it's one of the top 10, so I think they manage now $150 billion. When I left it was $130 billion. That’s two years ago, so they've done well.
2:33
Roman: Yeah, tell us about the role that you do right now for Sage.
Komson: Our investment process is driven from the top down: our view of the economy, our view of macro issues permeates really the portfolios and the strategies that we have. And so, you know, what I do is try to inform the investment committee of the macro environment. Formulating house views on where are we on economic growth? What are valuations telling us, what is prevailing market psychology? Sage is a little bit of a smaller firm, we have about 50 people, and you get to wear a lot of hats.
Roman: The joys of the small firm isn't it?
Komson: It's been great, and I really help on the investment process. I've taken on sustainable investing as well. So, just really interesting. It's been great so far.
3:40
Roman: Yeah, that's great. And, you know, one of the things that I hear you talking about is, you have extensive experience running the teacher, you know, the pension fund, a massive fund that is really concerned with making sure that their asset allocation selection is dialed in correctly. Coming over here to Sage, which is really serves a lot of pension funds as well. We have a lot of institutional business. And that might segue really nicely into kind of our topic today. And I hear this all the time from advisors in the field, they're confused about what does it mean? What does what does it mean to be strategic? What does it mean to be tactical? What are those differences?
Komson: Sure. And, you know, Roman, I want to take a step back here and talk about just in any strategy. Yeah, strategic or tactical, it's really most important to have really three aspects to it, versus, you know, you want to have a plan you want to have you want to be able to, you know, the importance of having a plan is to be able to measure success when you do want to measure success. So, you want to have that plan, you know, ex ante. Second, you want to be diversified. So, whether that means being diversified across asset classes or strategies you want to be diversified to mitigate your risk. And then third is stay invested. So we're big believers that asset classes, financial assets, especially equities rise over the very long term because they're linked to economic growth. So staying invested through the full market cycle is really important.
Roman: And it's also very tough, isn't it, for a lot of investors to do it?
5:19
Komson: It is tough. I think a big part of this game is psychology so staying invested near the lows, you know, easier said than done, but you look back at like the crisis and you look back at the valuation levels that existed at the time you say well, it's obvious you know, you should have bought credit, right equities. The key is just to have a plan, you know, to stick to that plan. Staying invested is really important. So, those are the three main principles.
Roman: Yeah, components in a good financial investment journey.
5:58
Komson: And so what it means to be strategic -- It's just when you talk about strategic asset allocation, there's really two big components, or three big components actually, when you think about them. First, you have to determine your expected returns. What are your long term expected returns? These asset classes, whether stocks, bonds, real estate, alternatives, or anything that you would you expect that asset class to give you in return over the long term. So, not necessarily during a bull market, during a bear market, during a crisis, but over the long term, what will those returns give you? And second, what is the risk of those asset classes?
6:40
Roman: Are we measuring risk by volatility primarily here, or?
Komson: Most people do. We’re referring to standard deviation of return. Equities could have equity-like risk, bonds going to be less risky by any measure. And then the third element is a covariance. So how does it measure, does it move, relative to other asset classes? What is the degree to which they diversify other asset classes? I'll take those three inputs. And this is just, you know, something you would learn in school, you know, it's called modern portfolio theory. You put that together, you try to build a portfolio that you would deem as optimal based on your risk level. So your risk levels are very short-term time horizon, you need income, you would effectively build a portfolio that would give you the risk-return profile that you want, but it's going to be optimized. So optimizes means that you the maximum amount of return for the amount of risk you're taking, right? Okay, so what that's what you do, and so you build that portfolio and that portfolio is then your baseline for a long-term holding of your portfolio. When you measuring success of asset classes, bonds and stock, sometimes people look at bond returns and say man, bonds aren't doing their job, they're negative on the quarter. But sometimes when you look at bonds, I really look at them as having three distinct roles in your portfolio. First, they’re returns-seeking, so when you’re looking to equity you want them to generate that return over time. Bonds will give you some return over time. But bonds have two additional roles.
8:25
Second one is diversification. So yeah, maybe a bond does not have a positive return this quarter, but does it do its job in diversifying during deflationary periods? And the third one is as hedging liabilities. So a liability for an individual could be a retirement income. Or liability for a pension fund could be their actuarial assumption of earning seven or eight percent a year -- you would insert fixed income you’re your portfolio in order to achieve that outcome.
8:56
Roman: And it sounds like what you're saying is that what a strategic allocation framework is geared at is, what is the purpose behind the funds that we're trying to invest? Let's first determine that. For most investors that we come across, whether they’re advisors or institutions, as you were alluding to there, they have future liabilities coming do in the future that they need to fund for, and they need to generate some type of return that allows them to do that. And putting together a portfolio that matches that purpose based on the expected return of various asset classes. Would you say that that is the framework through which strategic ---
9:36
Komson: Exactly. And so once you're done with a strategic asset allocation, then you have a portfolio of you know, the best market exposures you could possibly have for your risk level. And so you know, we're talking about strategic asset allocation managers versus tactical asset allocation managers. So strategic asset allocation managers would then stop there. They’ll say, we have the optimal exposures, and we want to outperform the market. We want to pick the best managers that outperform those particular asset classes over time. We're not going to change the weight of the equities or bonds, we are going to change the asset allocation. So the source of your performance, the alpha, will be security selection. So can these managers within these asset classes, pick better bonds and individual stocks and securities than the non-performing asset class.
10:30
When you turn that to a tactical manager -- so this is something that we do and we think that this is something that really drives more return over the long term -- is we want to be able to select the right market segment, the right asset class, and the right region, sector and style, for example, in equities over the long term.
Roman: Versus a manager or security selection.
Komson: Exactly. So we'll set some sort of risk level -- so the way we manage money is we have a conservative all the way to an equity portfolio, which is the most aggressive, and those will pertain to whatever risk level that you deem appropriate for your client. And then we will be tactical around those bands. So what that means is we will outperform the benchmark, or try to outperform the benchmark. We will manage a portfolio and take active risk around managing the asset allocation of the portfolio.
Roman: So we will play with the asset allocation a little bit.
11:30
Komson: Exactly, exactly. And it will be tilting the portfolio towards equities, bonds, emerging markets, you know, international equities, bonds, credit.
Roman: So instead of just putting a together a portfolio where the asset allocation is, for the most part, fixed and the manager selection might rotate, we're instead saying let's put together an asset allocation profile and we might play with the asset allocation mix a little bit, lean in to equities a little bit when we want to, ease off of equities a little bit when we want to. And then we might also rotate through the different market segments within those specific asset classes. And that's kind of the primary differences that you have between a tactical and strategic approach --
12:21
Komson: Definitely. It's where is your outperformance coming from? So strategic, you're either going to have no outperformance because if you're just choosing in a passive fashion you're not going to have any outperformance by definition. But if you choose to be active through security selection, as a tactical asset allocation manager, we attempt to outperform the market by picking the right asset classes or avoiding the right asset classes at the right time.
Roman: Alright, so what created these two different and distinct versions of active management or versions of management? What kind of philosophies underneath were driving those two different decisions? For instance, why did Sage adopt the tactical mindset that we currently have? What was driving our decision-making?
13:10
Well, I think for a strategic manager for let's say, you know, you’re investment manager that chooses to be in a in the asset allocation and that remains static over time, I think your belief system would have to, you know, be parallel to that of you know, an efficient market. It's really truly difficult to beat the market, if not impossible. And if you do, it's not based on skill, it's based on luck. And so you know, we obviously don't believe that. We believe there are inefficiencies in the market you can exploit, and so the way we do that is we look at the world in a multi-dimensional way, and we call it a multi-disciplinary approach. We think that we could position ourselves in a way that could outperform the market given valuations or prevailing growth environment or you know, market psychology.
Roman: Yeah, it sounds like we're basically making the assertion that markets can be efficient, but they're not always all the time efficient necessarily. Would that be fair to say in terms of our belief?
Komson: For sure.
Roman: One thing that might drive the fact that there are efficiencies or inefficiencies that are created, even in this day and age of a plethora of information and technology, is because markets are still, in some way, shape, or form are emotional. Would that be fair to say?
14:50
Komson: Definitely. We think that markets are emotional. Ultimately there's a lot of psychology, and that's something that we try to exploit with our analysis.
Roman: We've been talking about strategic asset allocation, we've been talking about tactical asset allocation. How does Sage view the world and what are some of the ways in which we approach the tactical asset allocation mandate?
15:14
Komson: Yeah, so you know, the way we approach tactical asset allocation, we approach the world in four major buckets. We just think that for every kind of macro-driven investor, every top-down investor, these are the key questions that you should have to be able to answer. To be able to invest in this fashion. So the first is the bottom, the anchor, which is economic growth. What are the prevailing growth conditions in the market? Not only just in the U.S., but globally, and how do they relate to each other? Where are we in the business cycle? So then the first factor is economic growth.
15:48
The second one is policy. So how does monetary policy, how are central governments conducting fiscal policy in response to these underlying growth conditions? Okay, so with those two things, you have the underlying conditions, you have the foundation. And no matter what the foundation really includes what the most important thing is, is how is the market interpreting that?
16:14
So the third one is, valuation. Valuation is, yeah things are great, but markets are expected to be euphoric. Which is different than, things are bad; the markets expected to be terrible.
Roman: And this goes back to us talking about how markets can not be efficient sometimes.
Komson: What is the market pricing in is the question that we're asking at right here. Is the market cheap, or is the market rich? By market I'm saying equities, bonds, the total financial assets as a whole. And so that's the third element is valuations -- housing market pricing, underlying prevailing conditions.
16:45
And then the fourth element of how we look at the world is what we call market psychology, or sentiment, or technical, or whatever you want to call it, is what is prevailing psychology in the market? So is it greed, is it fear? Things may be good. Growth maybe great, policy maybe accommodative, valuations could be cheap relative to those underlying fundamentals -- But if the market is in a fearful mood, let's say there's a news article that comes out that threatens geopolitical order or something like that, we have to take that into account. So those are really the four things I think we can answer those questions.
17:26
So the way that we look at the world and the way we build our models, the way we take in information, feeds into answering those major questions.
Roman: And then that then drives us to then say, okay, how do we want to position around these different, you know, conclusions that we've come to?
Komson: And so once we have those answers to those questions, or what we think are the answers those questions, we can then map those out to different asset classes. And so we think the growth conditions are great, assets are cheap, but maybe only cheap in the international arena, that may be an international equity allocation.
Roman: And that's where the tactical manager starts to add value. Because the strategic manager is not necessarily looking at that type of dissonance, they're looking at is a manager outperforming their certain asset class. Would that be fair to say?
Komson: Certainly. A long-term strategic manager, the really big thing that they try to follow is, we set out the expected returns over a real long term, is capital market assumptions. Their belief is that they hold over time. And so a tactical asset allocator is trying to adapt to the market and apply flexibility to those asset class allocations. If expected returns hold over the long term, that's one thing, but what is the path you take to get there? You know, I think the value proposition of active manager, the value proposition that we have is, that that ride will be smoother, these downturns in the economy -- So for example, if you're in a growth-oriented portfolio, going to be primarily equities. So you’re going to be suffering a deflationary period during the recession, and so I think that you know an active manager, a tactical manager, will be able to mitigate some of those downside moves in your portfolio given our active management.
19:21
Roman: And that could increase the likelihood of the client staying invested in the plan throughout the long term. If we can smooth on the ride, we can dampen the drama. A lot of advisors that we talked to in the field have this problem where the client agrees on the asset allocation, they agreed on the expected return. And then they start the investment journey. And it's almost as if that's where the hard part begins, is then fulfilling that investment journey, because clients either maybe they get bored with their investment plan, and they're hearing all about, you know, the new, newest hot thing in the market. Or maybe they're getting a little complacent. They're seeing, you know, certain asset classes surge and they're wondering why they're not a part of it. Or maybe they get overly fearful, and they want to make decisions that pull them out of their investment plan. And that's the very thing we're trying to prevent by being a tactical manager. Would that be fair to say or?
20:16
Komson: Yeah, exactly. I think it's, you know, when I mean tactical, we're always going to be invested
in everything, but we're going to tilt those exposures over time, so your risk profiles can be very similar to what you set out to have. So if you're 60/40 -- 60% equities, 40% fixed income, or that's your strategic asset allocation, you kind of set out at the very beginning, the way that we would manage your money would be around that risk profile.
20:48
Roman: Right, right. You know, it’s August of 2018, we have trade tariffs. Right now, we have rising interest rates, we have central banks kind of reverting course here. What might be some of the advantages of being tactical in the current environment that we find ourselves in?
Komson: I think the biggest driver of markets, you know, the biggest consideration that investors have to have right now is the nature of the public sector involvement in markets. Going to the crisis, you know, we really had minimal public sector involvement. And after the crisis, we had quantitative easing, we have central banks all over the world easing policy going to negative interest rates, rising assets pumping liquidity into the market. So now that we have growth at a at a point where they can exit -- You know, I think a lot of times, we talked about all, you know, a lot of these folks in the markets, I've never seen a hiking cycle. So therefore, how would they be prepared for this? I would posit that no one's really seen an exit from quantitative easing and asset purchase of this scale. The nature of that public sector involvement in markets is going to take the place of fiscal policy: tax cuts or infrastructure spending or whatnot across the world, or will it just be gone and has to be replaced by the private sector? That question is really important because that's really what drove the markets higher. Risk assets and bonds. And then that the nature of that compression in risk premium or compression volatility -- so central banks try to compress volatility such that the private sector would invest in the markets in order to prop up asset prices.
22:34
Now, they’re doing the reverse thing, right? What's going to happen? So that's, that's really something that, you know, I think about as a big factor and I think that is going to induce a lot of volatility going forward.
Roman: So you expect volatility to pick up as central banks continue to decrease the money supply.
Komson: Exactly. And I mean, this is an illustration that I keep in mind. So, you know, during the crisis, the policymakers are pushing a big boulder uphill. So what happens when you push a big boulder uphill, you're walking up there, and gravity is helping to stabilize that right, because you can kind of, you know, adjust, you can adjust the momentum. And you have a lot of leverage. And so what they're trying to do now is roll that same boulder, which, by the way, is like three times bigger, back down the hill. And so it's got the control. They're trying to actually raise volatility, not necessarily directly.
Roman: But that's actually the indirect effect of what they're doing.
23:39
Komson: And we're hoping that no one gets crushed. And so I think that you know, going back to, you know, tactical versus strategic, or active versus passive, this is really the best time to be in a tactical manager. It gives you that flexibility, at least gives you a chance, to avoid that boulder. Now, is it going to be easy? No I mean I think it's, you know we're in a very unorthodox economic expansions season and so but it's really exciting to us. You know rates are at the lowest in history right and whatnot but there's so many cross currents. There's overlay of politics, an overlay of long-term structural issues that there's enough to work with for a tactical manager, so we're definitely excited.
Roman: Fantastic Komson, thanks so much for joining us and thanks for being here. And to all listening, thanks for tuning in to the Sage Advisory podcast.
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