From Macro Idea to Portfolio Investment
Ask A CIO #34
How do institutional investors make macro assessments (e.g., on China, on Trump policies, on the future of AI, on COVID in 2020, etc.)? Do investment offices typically generate enough conviction (and institutional backing) to make outsized bets on these medium-term trends? If so, how are they expressed (e.g., lean X% more tech/China exposure)?
I would say there’s pretty wide variation across institutions in terms of team bandwidth and access to resources. Both factors obviously influence an institution’s ability to conduct primary research or independent analyses, which then impacts how or if an institution invests in opportunities and trends.
Let me give you a past example – investing in China, since you mentioned it. In the 2000s, China’s economy was shifting and modernizing, and the investment landscape was similarly evolving. Many institutions saw the potential for a multi-year, if not multi-decade opportunity. A small subset of institutions sent members of their teams “on the ground,” effectively setting up temporary satellite offices for a period of time.
Without commenting on whether these more extensive efforts ultimately led to better returns in China, it was evident that these efforts tended to result in earlier and/or larger investments in that market versus other institutional peers. In other words, these institutions appeared to build greater conviction both in the potential opportunity set and in the investments they subsequently made. The ability to do deeper, sustained research directly affected how these institutions expressed their viewpoints. No surprises here.1
The majority of institutions did not have the resources or capacity to create satellite offices, relying instead on external reports, data from investment managers, conversations with peers, and periodic trips to China. In other words, these institutions combined some amount of top-down macro research with some amount of bottom-up due diligence with managers who themselves were “on the ground.” Many of these institutions also invested into China, though perhaps (but not always) at later intervals or with smaller allocations.
I think this second approach is more representative of how most institutions approach most opportunities (even the best resourced institutions typically aren’t generating satellite office type efforts). It is in many ways a market mapping exercise, except the investor is still deciding on the merits of that particular market.
What does it look like in practice? In short, it’s an iterative process of analyzing publicly available data and research, then validating it against proprietary data and insights from managers with market expertise. Rinse and repeat across many managers and likely over many months.2
With each iterative phase, either the market thesis holds and the process continues, or it doesn’t, and the process ends. Importantly, the process also usually ends if the investment office can’t gather conviction around an investment manager to execute the thesis. Sometimes a market or trend is genuinely compelling, but absent a compelling manager in the space, institutional investors are still likely to pass.
Identifying an opportunity is only half the challenge, and I would argue it’s the lesser half. The greater challenge often lies in the execution of the opportunity. As you noted, in how viewpoints are expressed through actual investments. Using China in the 2000s again as the market example, institutions had to decide: should they invest in China long-only equities? Long/short equities? Private equity? Venture capital? Should they even invest in China-only funds or instead through broader Asia funds?
And this takes me back to one of the fundamental building blocks of endowment-style investing. In markets in which depth of experience and expertise can translate into competitive advantages, it’s important to invest with the right people. The larger the potential competitive advantages, the greater the imperative to invest in the right managers. In the end, for many institutions investing into China, the strategy they chose was inextricably tied, and perhaps secondary to, the manager they chose.
Finally, to explicitly push back on part of your question – institutions generally aren’t looking to take outsized bets, trend or no trend. They’re looking for investments within their asset allocation frameworks, overweighting (or leaning into) opportunities as appropriate. And institutional investors would more likely describe these overweights as calibrating investment dollars toward multi-year opportunities with managers that can offer outsized reward for the risks undertaken. It may sound like semantics, but I promise you it isn’t.
Thanks for joining this week! As always, feel free to reach out with any questions: askacio@ivyinvest.co.
Until next week,
Wendy
Investing at that time was also mechanically complex, as Chinese capital markets were still mostly closed to international investors (there was a whole complicated QFII allocation system).
Shorter term dislocation opportunities, such as those that arose in COVID, require a different approach. In the bluntest terms, investors are either set up in advance of the dislocation to capitalize on it (e.g., pre-existing relationships with managers that are investing into the dislocation) or they’re not. In reality, there is no getting up to speed on the fly in the midst of a dislocation.