When investing, clients should only take “rewarded” risks as these represent the fundamental objectives of investing.

1. 2016 | 01
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STANLIB is an Authorised Financial Services Provider
RISKSSHOULD
REWARDNOT
DETRACT
BY RENATE
POTGIETER,
PORTFOLIO
MANAGER, STANLIB
MULTI-MANAGER
WHEN INVESTING,
CLIENTS SHOULD
ONLY TAKE
“REWARDED” RISKS
AS THESE REPRESENT
THE FUNDAMENTAL
OBJECTIVES OF
INVESTING. There is no
benefit to taking unrewarded
risks and as such clients
should minimise these as far
as possible.
An important unrewarded
risk that investors face is that
their investment outcome
does not match their
expectations. This source of
risk arises when the investor
and the investment product
are not aligned. There are two
aspects to consider in order
to minimise this risk. Firstly
the client objective, covering
whether this is appropriately
set, communicated
and understood, and
secondly, the subsequent
design, construction, and
management of the portfolio
looking to achieve the stated
objective.
In this article we will identify
these risks and help investors
to understand them and how
we can mitigate them.
START WITH
THE END
IN MIND
The first step in our
investment process is
product specification and
the setting of appropriate
portfolio objectives. In other
words, start with the end
in mind. This is crucial as
the entire solution stems
from this specification.
This is equally true whether
building a bespoke solution
for a client, where the client’s
customised objective is
of primary concern, or in
building a more general
solution for investors to
select.
If the solution is not aligned
to investors’ requirements
and expectations, it is
irrelevant whether it
performs well or not (in
fact, performing well has
no meaning). The risk
is therefore that either
the product is poorly
communicated to clients
(leading to misunderstanding
from clients), or that the
client has communicated
their needs poorly (leading to
misunderstanding from us).
Aprimarytooltomitigatethis
riskisclearcommunication,
insimplelanguagethatclients
willunderstand.Assuch,
weneedtoassistclientsto
recognisehowproducts
behaveandwhattheycan
expectfromtheminvarious
marketenvironments.
My favourite test is to
ask whether my sister, a
physiotherapist with no
investment training and
limited knowledge, would
understand the information
provided. We need to make
the information real, for
example if as an investor
you believe that you need
to take on equity risk, you
need to understand that
over time this could result
in higher returns than the
other conventional asset
classes, but as a riskier asset
class, it can also result in
your investment halving
which is what happend
during the Global Financial
Crisis in 2008, or worse as in
the great depression of the
1920s and 30s.
We as a Multi-Manager
are in the position to
provide clients with
greater understanding of
how a particular product
may behave in different
environments (such as
market corrections or
extended bull markets)
because we spend our time
understanding this. We
deploy this understanding
within our own solutions to
create more certainty for
investors than if they were
to invest in just one of these
managers randomly.
ARE YOU GETTING
WHAT YOU THINK
YOU ARE?
Another important aspect
of client objective risk is
an understanding of what
the client’s investment is
measured against, i.e. the
benchmark. We believe that
what is “on the tin” should
represent what is “in the tin”.
For example the STANLIB
Multi-Manager Global Equity
Fund benchmark is the
MSCI All Country Investable
Markets Index, which
incorporates developed
markets, emerging markets
and small capitalisation
stocks, as opposed to the
MSCI World Index which
only represents developed
markets.
If the
solution is
not aligned
to investors’
requirements
and
expectations,
it is irrelevant
whether it
performs well
or not (in fact,
performing
well has no
meaning).

2. 2016 | 02
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STANLIB is an Authorised Financial Services Provider
By benchmarking our fund
appropriately, investors are
able to decide whether they
want to take on the risks
associated with emerging
markets or small caps, or
not. We also believe an
appropriate benchmark
representative of the fund’s
investment universe enables
investors to better assess
the portfolio performance
as it minimises the amount
of off benchmark holdings
(holding a stock that is not
in the benchmark). This
thereby minimises the
amount of market return
(beta) being shown as fund
manager skill (alpha) – this
is particularly important
if performance fees are
charged. An appropriate
benchmark further assists
in minimising the risk of the
client’s expectation being
unaligned to the solution.
SEEING THE WHITES
OF OUR CLIENTS EYES
Another risk mitigation tool
to better align the client’s
needs and expectations
to the solution is through
detailed conversations with
the client during meetings,
or during the product
specification stage for
customised solutions.
We believe in looking at as
many possible variables
to describe the portfolio
to ensure that what we
understand the client’s
needs to be, is actually
what the client is looking
for. For example, in addition
to the benchmark, we can
indicate the typical degree
in variation of the returns
(volatility range associated
with the product), by how
much the product and
benchmark can differ
(the tracking error to the
benchmark), as well as the
typical asset allocation or
sector allocation ranges
(for example the maximum
exposure to credit in a bond
fund).
KNOWWHAT
YOUAREPAYING
The risk of the expectation
and outcome not being
aligned can also arise when
considering the fees paid
by clients. This risk is not
whether the fee charged
is appropriate or not, but
rather whether the fee
paid is in line with client
expectations. For example if
a client invests in a product
which charges performance
fees, and the product
outperforms the benchmark
which results in an additional
4% of performance
fees being paid, was this
expected?
Was the client aware that
the potential performance
fee payable could be this
high, and is he/she paying
for actual performance
received, or was the fee
based on past performance
that the client did not
enjoy because they only
recently invested in the
fund? This again brings
me to my argument that
communication from
product providers needs to
be clear so that clients are
able to make an informed
decision on whether they are
happy to pay the fees being
charged and potentially for
past performance that they
will not be enjoying.
PORTFOLIO DESIGN,
CONSTRUCTION,
AND ONGOING
MANAGEMENT
Once we have gone through
the portfolio specification
process, there remains
the risk that the portfolio
does not meet the stated
objective. To ensure that
the final solution performs
in line with expectations,
we spend considerable
time in understanding
the active managers we
may use as well as any
operational risks that arise
when placing money with a
specific manager. Reducing
the buy list to the managers
we allocate money to is a
complex process which
takes numerous factors
into account, while client
objective is top of mind.
We begin by analysing the
market and establishing what
the key drivers of returns
are and whether any natural
tailwinds exist given the
client objective. With this
knowledge we assess the
alpha potential of our buy list
managers by understanding
their skill given the
investment universe and the
identified tailwinds.
We then construct a
framework to build a
well-diversified portfolio
which allows for manager
independence and flexibility,
while ensuring the overall
portfolio has exposure to the
key drivers identified.
The final strategic manager
allocation is determined to
create a well-diversified,
balanced portfolio that
reflects the identified
market, manager and
portfolio factors. For
example we think for a
global equity fund the
underlying managers
should be given global
mandates. We believe this
to be a more efficient way
to invest when compared
to regional mandates as
global mandates provide
managers with the widest
possible investment
universe covering all sectors,
geographies and currencies,
allowing them to invest in the
best opportunities available
globally.
To avoid the risk of any one
manager dominating the
portfolio, we set a maximum
exposure to a manager. To
allow for the different skills
that each manager brings
to the portfolio, we may set
different benchmarks to
the underlying managers
to be able to assess
them appropriately and
leverage their unique skills.
We will then ensure that
the combination of the
different managers and

3. 2016 | 03
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STANLIB is an Authorised Financial Services Provider
their benchmarks remains
reflective of the client's
objective we have set out to
achieve.
Prior to finalising our
portfolio, we review
the proposed solution
considering multiple aspects.
For example, we evaluate
the underlying holdings
through time, testing
for any concentrations
or unintended biases.
We will also look at past
performance to understand
how the managers and the
multi-managed solution
perform in different market
environments, such as during
the global financial crisis.
Once the portfolio is
constructed it is important
to keep assessing whether
it continues to meet the
client’s objective given any
changes in the environment
as well as changes within
managers. This portfolio
review process provides
an important feedback
loop into the product
specification. This is
primarily assessed through
our close relationships with
managers, the reporting we
receive from them as well
as the strength of our entire
investment team’s view.
We are firm believers in the
power of collective wisdom,
and through rigorous
internal debate ensure that
we remain objective about
our managers. Managers’
current holdings and
performance are inputs
into this process. When
assessing performance we
are careful not to overreact
to short-term performance
(unless it is completely
different to what we would
have expected), and
specifically, not to react
to underperformance by
managers which we assess
to be good. Our governance
structure (and committees)
requires thoughtful
consideration of portfolios
and a robust thesis for any
proposed changes. If we
have done our work well
upfront, we better have a
good reason for changing it.
SUMMARY
Astheinvestment
environmentandclients’
objectivesareeverchanging,
wedoalloftheaboveona
continuousbasistoensure
thattheproductremains
appropriateforourclients.
Wecontinuetocommunicate
clearlythroughpresentations
andfactsheets,sothatclients
remaininformedonwhatto
expectandhowthingshave
changedwithtime.
If any new information
is garnered from client
interactions or the
environment in which we
invest and our underlying
managers that is relevant
for how we construct the
portfolio, we re-optimise
the solution to ensure this
additional information
is incorporated into the
solution and communicate
this to our investors.
However, as mentioned,
we remain diligent in our
evaluation of manager
performance and the drivers
thereof to avoid overreacting
to any underperformance by
good managers.
Investment risks are multi-
faceted and as such require
dedicated focus to all
aspects. A portfolio manager
has to account for all risks
envisaged to ensure the
product delivers in line with
its objectives and client
expectations.
As we have stressed in
this article, the clients’
investment outcomes are
continuously top of mind.
We strive to understand
and communicate the
complex investment world
into information that
clients understand, thereby
empowering clients to invest
wisely.
AS THE INVESTMENT ENVIRONMENT AND CLIENTS’
OBJECTIVES ARE EVER CHANGING, WE DO ALL TO
ENSURE THAT THE PRODUCT REMAINS APPROPRIATE FOR
OUR CLIENTS