How SPW PDPS portfolios are actively managed

At Schroders Personal Wealth (SPW) we advocate an active approach to investment management. In this article we outline what this means in practice.

There are two fundamental ways to manage portfolios and funds: active management and passive management. Let’s first consider passive management.

Passive portfolios and funds simply aim to replicate the performance of an investment index. Indices, in turn, aim to measure the performance of particular types or combinations of investment assets.

The best-known UK index is the FTSE 100. This index measures the collective performance of the equities (shares) of the 100 largest companies in the UK with a stock market listing. In other words it is an index for the equities of large UK companies. A FTSE 100 passive fund would simply aim to accurately replicate the performance of the FTSE 100.

Indices such as the FTSE 100 are often used as benchmarks for the performance of active funds or portfolios. Active funds or portfolios are run by fund and portfolio managers who aim to offer better returns than their index benchmarks, rather than simply matching them. So a fund manager running an equity fund comprising large UK companies, with the FTSE 100 as its benchmark, would try to secure higher returns than the FTSE 100 index.

Fund and portfolio managers typically aim to beat their benchmark indices by investing more, proportional to the benchmark, in holdings they believe have the potential to grow more strongly than the benchmark index. And they also typically invest less, proportional to the benchmark, or have no exposure at all, to holdings they believe could potentially perform more weakly than the benchmark.

SPW’s Personal Discretionary Portfolio Service

SPW runs nine Personal Discretionary Portfolio Service (PDPS) portfolios, each with a particular risk level. PDPS portfolios are multi-asset portfolios, which means they can invest in a wide range of assets, including equities, government bonds, corporate bonds, property, commodities, absolute return funds and cash.

The PDPS range extends from lower risk portfolios for cautious investors right up to higher risk portfolios for more adventurous investors. Lower risk portfolios typically contain a relatively large allocation to lower risk investment assets, such as government bonds. Higher risk portfolios typically contain a relatively large allocation to higher risk investment assets, such as equities.

SPW has ultimate oversight of the PDPS portfolios and, crucially, decides on the long-term blend of assets within them (the ‘strategic asset allocation’). But the day-to-day management of PDPS portfolios is undertaken by the multi-asset team at Schroder Investment Management (SIM).

These PDPS portfolios each contain a series of underlying funds. Most of the underlying funds are SPW Multi-Manager funds but PDPS portfolios also contain some funds run by external fund management houses and some contain the SPW Asset Allocator fund (which is explained below). Most of the funds held in SPW PDPS portfolios are active funds, but they also include some passive funds where these are thought to be appropriate.

Composition of SPW Multi-Manager funds

The SPW Multi-Manager funds, in turn, each comprise a series of underlying ‘segregated mandates’ run by external fund houses as well as some underlying segregated mandates run by SIM itself. A segregated mandate is a collective investment run exclusively for a client, typically a financial institution, such as SPW. The SPW Multi-Manager European ex-UK Equity Fund contains the following segregated mandates:

• BlackRock European Flexible

• Invesco European Equity

• Schroder European.

Many multi-manager funds operate what is known as a ‘fund of funds’ structure, in which the multi-manager holds a series of underlying investment funds. But, at SPW, we believe there are key benefits to holding underlying segregated mandates rather than underlying funds. In particular, segregated mandates offer SIM’s multi-manager team greater oversight than is available with a typical fund structure. SIM is also able to negotiate lower cost fees on segregated mandates than on typical funds.

When putting together SPW Multi-Manager funds, SIM’s multi-manager team works in conjunction with other SIM teams. In particular, it works with SIM’s multi-asset team and its fund and manager research team.

Asset allocation

SPW decides on the long-term blend of assets within PDPS portfolios (the ‘strategic asset allocation’), but SIM’s multi-asset team adjusts this blend of assets in the short term (the ‘tactical asset allocation’).

Some PDPS portfolios contain the SPW Asset Allocator fund. Holdings in the Asset Allocator fund are changed in line with the SIM multi-asset team’s views on current economic and market conditions. This enables portfolios that contain the Asset Allocator fund to respond to these conditions. But the multi-asset team also makes changes to holdings in PDPS portfolios outside the Asset Allocator fund.

When making these adjustments, SIM’s multi-asset team considers the broad economic backdrop, which includes factors such as economic growth, inflation, interest rates and market conditions. The team then assesses if it wants to position portfolios so as to grow the capital (if market conditions look favourable) or to preserve the capital (if market conditions look challenging). It also decides how it wants to weight its holdings in various asset classes, such as equities and bonds. And it decides on which geographical regions or industry sectors it might want to invest more in and which it might want to limit exposure to.

Selecting investment managers

SIM’s multi-manager team chooses the underlying investment managers with specific goals in mind:

• Aim to identify managers that are the best in their sector or specialism through rigorous analysis.

• Select and blend underlying segregated mandates to hopefully ensure the portfolio is correctly positioned for the prevailing economic and market conditions.

The multi-manager team conducts regular face-to-face meetings with investment managers of underlying segregated mandates. This enables the team to assess each mandate’s overall investment philosophy and its investment team.

In particular, the team considers the following:

• How an investment manager views investment risk

• The segregated mandate’s investment time horizon

• How managers select individual stocks. Is it based on economic trends or, perhaps, on individual stock selection?

• Is the segregated mandate well diversified?

• Is the segregated mandate run by a team or an individual? Who are the key risk takers? Who are they influenced by?

Monitoring downside risk

The multi-manager team pays close attention to what is known as ‘downside risk’. This means it aims to position portfolios to avoid significant losses. The team believes avoiding such losses can help secure favourable long-term investment returns.

This table of two hypothetical investments, ‘A’ and ‘B’, with different annual returns over a five-year period, is shown purely for illustrative purposes and reveals how this can work in practice:

Based on the individual annual returns, you might expect the cumulative five-year returns of Investment B to exceed the cumulative returns of Investment A. But that’s not the case: the cumulative five-year return of Investment A is higher. This shows how large one-off declines can negatively impact long-term portfolio performance.

Finally, SIM’s multi-manager teams seeks to ensure that underlying holdings blend well together within SPW’s PDPS portfolios, aiming to provide good overall investment performance in line with the risk profile of the funds or portfolios.

At SPW we believe these active investment processes can help us with our aim to get our individual portfolios and funds to beat their respective performance benchmarks. And we hope these robust processes can provide reassurance to both existing and potential investors.