On identifying a ‘right to win’, guarding against style drift and the best use of active funds
In our regular video series, we interview the wealth sector’s key decision-makers to discover how they think about life, both within the world of investment and beyond it; what brought them into the business and what keeps them here; and what makes them and their companies tick
Does a fund manager have a ‘right to win’ within their asset class? If he can identify one, it can be a key selling point for Daniel Nilsson, portfolio manager at Isio Investment Management, when he is building portfolios for clients.
“At the heart of it, we are fund selectors and, from an active management perspective, we look at a number of different facets,” he tells Wealthwise editorial director Julian Marr in the above video. “Firstly, we want to get comfortable from a business and corporate perspective – the profitability of the firm, the size of assets within that strategy and the underlying client base as well.
“Then, from a team perspective, we really like at least a co-PM structure and a well-resourced team with delineated responsibilities. Over the last 10 years, we have seen a lot of failures of strategies that have been aligned to star PMs or star stockpickers – so we prefer that collegiate team approach.
We want every asset or exposure within our portfolios to play a certain role. Think of a cricket team – you might select six batsmen, four bowlers and an all-rounder – and they all play a part in that process.”
“From a process and investment philosophy perspective, we are really looking at, What is the manager’s ‘right to win’ within that asset class? So what stands out about their process versus their peers and, importantly, can they execute on that process going forward? And have they done so historically?
“Here we are also looking at, Have they executed in line with their style? And that can be from an investment style or a size perspective. I always give the example of how global smallcaps play a specific role within our portfolio so we want our smallcap managers to access smallcap stocks – we don’t want that exposure drifting into midcaps or largecaps.”
Important role
Nilsson returns to the need to be vigilant against ‘style drift’ later on, explaining: “We want every asset or exposure within our portfolios to play a certain role. Think of a cricket team – you might select six batsmen, four bowlers and an all-rounder – and they all play a part in that process. They each play a role – and an important role at that.
“So if we are designing a global equity portfolio, we might use a largecap value fund and then blend that with a largecap growth fund to try and diversify the performance outcomes of the portfolio. The last thing we would want to see is that value manager drift into growth stocks, say, as you are then doubling up on that growth factor exposure.”
Turning to alternative investments, to what degree does Nilsson think retail investors should be using them ahead of more ‘traditional’ asset classes? “At Isio, because of our institutional heritage, we have done a lot of work within alternatives,” he replies.
“We have seeded and co-created alternative solutions within diversified credit, asset-backed securities and various aspects of the private markets value chain. And having that institutional capital behind us, and those client types, allows us to co-create funds, given we can pledge billions of pounds to basically create exposures.”
Insurance-linked securities
One area Nilsson highlights for its potential to deliver uncorrelated returns is insurance-linked securities. “These delivered a positive return during the GFC and throughout the Covid 2020 era,” he continues. “And in 2022, when equity markets were off circa 15% to 20% and most bond markets saw double-digit negative returns, insurance-linked securities still provided a slightly positive return. It is an area we like, we have looked at and we have allocated client capital to.
“There are plenty of other areas within alternatives but the difficulty for retail and wealth management clients is around liquidity. As we know, there are platform restrictions as well around daily-priced funds but there are still options – liquid alternatives, listed infrastructure, absolute return – so those are the sort of spaces we are looking at from a retail wealth management perspective.”
A full transcript of this episode can be found after this box while you can view the whole video by clicking on the picture above. To jump to a specific question, just click on the relevant timecode:
00.00: What excites you about the current investment outlook? What worries you?
02.46: What do you most look for in an individual investment? What constitute ‘red flags’?
05.43: What are your thoughts on style-drift? How do you cope with points in time when it might be uncomfortable to maintain investment discipline?
07.17: To what degree should professional investors be thinking beyond so-called ‘traditional’ investments? Towards what?
09.12: What drives your approach to client communications? Should professional investors aim to attract the ‘right’ type of client?
10.49: How you would define value for money in the context of investment?
12.19: What was your path into investment – and, if you hadn’t taken it, what do you think you would be doing now?
13.54: What was the biggest investment mistake you are prepared to admit to – and what did you learn from it?
15.13: Outside of work, what is the strangest thing you have ever seen or done?
16.27: Two Choice Words recommendations, please – one a book; one a free choice?
Transcript of Choice Words Episode 33:
Daniel Nilsson, with Julian Marr
JM: Well, hello and welcome to another in our series of ‘Choice Words’ videos, where we get to speak to the great and the good of UK fund selection and UK fund research. I am Julian Marr, editorial director of Wealthwise Media, and today I am delighted to be talking to Daniel Nilsson, portfolio manager at Isio Investment Management. Hello Daniel.
DN: Hello Julian, lovely to be here. Thanks for having me.
JM: I hope you feel the same way in 20 minutes! Brilliant to have you here. Let’s jump straight into the first question – what excites you about the current investment outlook? And what gives you pause for thought?
DN: I might start with what gives us pause for thought at Isio. I think the current market volatility has really brought to the fore the importance of designing robust, diversified portfolios. So at Isio, one of our core investment beliefs goes back to setting that long-term strategic asset allocation – and what I mean by that is sort of a five to 10-year focus.
So we don’t make dynamic or tactical tilts – well, I say we don’t … so, over the last three weeks, you know, markets are down, circa 6%, 7%, 8% across the world’s developed markets. But if you take a step back and look, we are really back to the start of the year in terms of an investment perspective. So the FTSE All-Share has delivered a positive return year-to-date. I think it is important to have that in mind when you are seeing constant negative press in the media about ‘trillions’ being wiped off markets.
And, really, communication comes to the fore at a time like this. So we have been very active, communicating with our client base on a weekly basis around how we have designed and developed their portfolios. So from, I guess, a market volatility perspective and looking at that at a holistic level, we are really talking to our clients around looking back to their-long term objectives – so that has been a big focus for us.
What I am excited about is the potential for diversified returns across various asset classes. For the last 10 years, you could have sat in a 60/40 portfolio – equities and bonds – and delivered a sort of 9% or 10% annual return. We don’t think the next 10 years will look like that. So this gives us an opportunity to really leverage our institutional heritage to access alternative, private asset-type exposures that we think will hold out really well over the next 10 years.
JM: Thank you for that. I don’t normally admit to when we record these because I can be quite lax in writing them up as swiftly as I might do! Not all the time – just occasionally! However, today is 26 March – I feel I should ‘timestamp’ that one – just so we all know where we stand. Sometimes honesty is the best policy.
‘Right to win’
JM: Thank you for setting the macro scene so well. Let’s now focus in on the individual investments you think about as your day job. What is a real selling point for you for a strategy – and what would you see as a red flag?
DN: We are fund selectors, at the heart of it. We don’t pick our own direct stocks or direct bond items within our portfolios. We select third-party funds – so we do a lot of research across active and passive management. From an active management perspective, we look at a number of different facets. So, firstly, we are looking at the business and corporate level – you know, the profitability of the firm, the size of assets within that strategy and the underlying client base within that strategy as well.
Getting comfort at a business and corporate level is important – especially with smaller boutiques. Over the last three or four years, we have seen a number of those shut down and close funds, due to not just performance issues, but sub-scale assets. So at the heart of it, number one, we want to get comfortable from a business and corporate perspective.
From a team perspective, we really like at least a co-PM structure and a well-resourced team with delineated responsibilities. Over the last 10 years, we have seen a lot of failures of strategies that have been aligned to star PMs or star stockpickers – so we prefer that collegiate team approach.
From a process and investment philosophy perspective, we are really looking at, What is the manager’s ‘right to win’ within that asset class? So what stands out about their process versus their peers and, importantly, can they execute on that process going forward? And have they done so historically?
From a philosophy perspective, we are also looking at, Have they executed in line with their style? And that can be from an investment style perspective – so a value or growth manager – or it could be a size perspective. I always give the example of how global smallcaps play a specific role within our portfolio so we want our smallcap managers to access smallcap stocks – we don’t want that exposure drifting into midcaps or largecaps.
It is the same if we are blending a value manager with a growth manager – we don’t want our value manager, you know, leaning more to a core growth approach if, say, there has been a period of underperformance within value.
From a red flag perspective, I mentioned that ‘star PM’ who has been associated with a fund – that is something we look out for. Also, AUM and profitability of the firm – because we don’t want strategies to be closed. Capacity is another aspect we look at quite closely – so we are conscious, especially within smallcaps, of some strategies running too much money, which obviously impacts their ability to go into certain stocks, especially lower down the market-cap spectrum.
Different flavours
JM: Thank you for that. Let’s go back to the ‘style drift’ point – how do deal with investors who are finding it difficult to stick to whatever aspect of the ‘building block’ you bought them for a portfolio?
DN: Yes, it is very important for us – especially with designing portfolios. You know, we want every asset or exposure within our portfolios to play a certain role – and I always think of a football team or a cricket team. You might select six batsmen, four bowlers and an all-rounder – and they all play a part in that process. They each play a role – and an important role at that.
If we are designing a global equity portfolio, say, we might use a largecap value fund and then blend that with a largecap growth fund to try and diversify the performance outcomes of the portfolio. So the last thing we want is then to see that value manager drift into growth stocks, as you are really doubling up on that growth factor exposure.
It is important as well, when looking at overall returns and communicating to clients, that investment styles have their different flavours from a performance perspective – you know, often value and momentum will perform in different environments.
Growth and value stocks will have sort of four or five-year periods where they will significantly outperform the broader market. Stepping back and having that context in line when you are designing and building portfolios and then communicating that clearly to clients is very important.
Insurance-linked securities
JM: We will get on to client comms a bit more in a second but, just in terms of investments, let’s broach the subject of alternatives. To what degree do you think professional investors need to be looking beyond the ‘traditional’ assets of equities, bonds and cash – and towards what?
DN: It is a great question. At Isio, because of our institutional heritage, we have done a lot of work within private markets and a lot of work within alternatives. We have actually seeded and co-created alternative or private market solutions within diversified credit, asset-backed securities and various aspects of the private markets value chain.
And having that institutional capital behind us, and those client types, allows us to actually co-create funds, given we can pledge billions of pounds to basically create exposures. So we have done a lot of work in areas such as private debt and private credit – insurance-linked securities is another area we have done a lot of work in and we like, given the uncorrelated returns it has provided.
Insurance-linked securities, for instance, delivered a positive return during the GFC and delivered a positive return throughout the Covid 2020 era. And in 2022, when equity markets were off circa 15% to 20% and most bond markets had double-digit negative returns, insurance-linked securities provided, you know, a slightly positive return. So that is an area we like, we have looked at and we have allocated client capital to.
We think there are plenty of other areas within alternatives but I guess the difficulty from a retail and wealth management perspective is around liquidity. As we know, there are platform restrictions as well around daily-priced funds. Still, there are options around, you know, liquid alternatives, listed infrastructure, absolute return – so those are the sort of spaces we are looking at from a retail wealth management perspective.
No excuse not to be proactive
JM: Good stuff. Let’s move on to client comms then. What is the Isio approach to communicating with clients? And, if I can add one specific angle, how much store do you set by attracting the ‘right’ type of client, by which I mean somebody who is going to stick with you through the whole process – being there at the beginning and, crucially, there at the end so they fully benefit from your wisdom?
DN: Client communications is at the heart of our approach and that stems from having a heritage with large institutional clients – you know, trustee boards, DC, DB, LGPS clients – that have strict procurement and trustee board meetings and so on.
So, now we are working in the retail wealth management space with independent financial advisers who are allocating to us and partnering with us to deliver MPS portfolios and white-labelled solutions, we are in constant communication with our clients – from weekly updates and podcasts to check-in calls and monthly factsheets.
So communicating our approach and how we go about designing portfolios has been paramount to building trust within the retail and wealth management space. So it is something we will continue to do with our client base – and especially throughout that March period, where we had some extreme volatility in markets, we were nearly having daily updates with our IFA client base.
That has been really well-received – and obviously, with the technological advancements and the different media and ways you can communicate with clients these days, there is no real excuse not to be proactive from a from a client communication perspective.
JM: Proactive but not too proactive, perhaps – that balance is important!
Efficacy and efficiency of active management
JM: A side question on all that, I guess is – how would you define value for money in the context of investing?
DN: Value for money is an area that gets a lot of thought at Isio – and a lot of it goes back to the active versus passive debate. We don’t see them as rivals – we use active management and we use passive management within our portfolios, within our portfolio construction approach.
And a lot of that stems from the research we have done, looking at the data on SPIVA, looking at the data on Morningstar in terms of their active versus passive ‘Barometer’ reports. And we have designated global smallcaps and emerging markets, within equities, as two areas we think active management adds value. And we think developed equities is an area where you can get passive exposure.
Then, on the credit side, we use active management across the majority of our credit exposures. That really derives from the fact that we have no government bond exposure and we have little corporate bond exposure, which a lot of our peers do.
But what it means is a lot of index or passive exposures cater to the corporate bond and government bond market whereas areas we utilise within credit – asset-backed securities, high yield – it is difficult to get passive exposure. So our approach is to take a blended exposure to our portfolios. And really, at the heart of that, is that ‘value for money’ approach where we only want to pay active management fees where we really think there is efficacy and efficiency of active management.
Work and play
JM: Thank you. A more personal question now – what was your path into investment? And, in an alternative universe, what do you think you would be doing if you had not taken that path?
DN: Really good question. I got into investments at a young age while still at university. I played cricket on the weekends and the captain of my cricket team actually ran a wealth management business. So I was in my second year of university and I sort of asked if there was any part-time work while I completed my finance degree back in Melbourne, in Australia.
And he said, Look, we can take you on, three days a week, in a junior role as sort of the secretary of the investment committee. It was quite an enjoyable role – I was responsible for all the meeting minutes, the agenda items, all the performance reporting and I got to join all the manager meetings and take all the notes.
That progressed and then, when I finished my university degree, I was offered a full-time position and became more involved in the asset allocation and the manager selection – and then, eventually, in creating and designing model portfolios. So that is how I got into the industry – I was lucky enough to utilise those connections, which can be very helpful, especially in this day and age.
As for what I would be doing if I wasn’t working in the investment field – you know, being an Australian, I love my sport, so I would have loved to play Test cricket for Australia or, you know, Aussie Rules football for Carlton, which is my team back home. But I’m not good enough for that so I would have been involved in sports administration in the back office, front office, middle office – something to do with sports administration.
Radioactive portfolio
JM: Good stuff. What is the biggest investment mistake you are prepared to admit to? And what, if anything, did you learn from the experience?
DN: This stems back to when I started my work experience at my first job. Being a university student, I had some time on my hands – more time than I have now with two young kids – and I did a fair bit of stock research. I used to buy a few speculative gold and uranium-type stocks out in Western Australia – you know, that micro and smallcap investing that is very high volatility, but it meant the gains were enticing at the time.
It also meant there were some big losses! There were some very volatile markets and I didn’t have a long-term investing plan back then. So I guess my big lesson was the importance of compounding wealth over a long period of time – you know, looking through market noise and setting price targets on investments.
And diversifying across asset classes – I was heavily involved in Aussie equities in a specific sector. So now I look at diversifying portfolios across asset classes, across sectors and across regions. I think that is the biggest learning point from a young investor starting out in the industry.
Long-distance, long-term
JM: Nicely done. Everyone’s favourite question on these interviews now – outside of work, what is the strangest thing you have ever seen or done?
DN: I had a good laugh when this question came through, thinking about what I could speak about. For this question. I think …
JM: It sounds like you are self-censoring! What is the strangest thing you could admit to!
DN: Yes! People would probably find this one a bit strange these days but I met my future wife on study exchange – actually in the UK, 10 years ago – at the start of our degree. So we were first-year university students and, you know, we did ‘long distance’ for three years. I moved back to Australia after I finished my study exchange semester in the UK and she would come out to Australia every six months.
I would then go back to the UK on my university break and she would come back out to Australia – and we sort of did that for three years, until she moved over to Australia full-time when she finished her degree. And I think, with this day and age and technology, people would probably find that a bit strange. But, yes, we had a long-distance relationship for three years – and now we are married with two kids so I think it has worked out.
JM: Yes. I guess it is not strange that it happens – it is strange when it succeeds, actually. Still, that is a good, committed long-term investment!
Random walk, broader horizons
JM: Gosh – we are zipping through these. Last question, then – we call this series ‘Choice Words’ because of what you do for a living, but we are looking for two personal recommendations now. One can be a book – it can be on investment but it doesn’t have to be – and one is just a ‘free hit’. Something you think our viewer – God bless you! – our audience would be interested in.
DN: From a book perspective, what really framed my approach to investing in the early days – so when I was starting out in the industry – is A Random Walk Down Wall Street by Burton Malkiel. He talks about how, for many investors, just taking a long-term, passive approach will likely lead them to a better outcome than technical trading, say, or picking active management.
That is not to say there isn’t a role for active management but it goes back to our approach around value for money at Isio – honing in on asset classes where we think active management adds value and using passive management in more efficient areas of the market, like largecap developed equities. It also looks at the broader picture around seeing that long-term strategic asset allocation – so I think that’s a really interesting book.
JM: It is interesting that, for such an important book, this is the first time it has been mentioned on Choice Words.
DN: And then, as a sort of free choice, I think it is getting outside your comfort zone. So, from my perspective, I did a study exchange – I moved to the UK for a period of time to study over here. Post that, I did an internship in Malaysia – in Kuala Lumpur.
So getting that variety of experiences and working in different cultures – obviously, I am working over in the UK now – I think really broadens your horizons, which can be beneficial from not just a personal perspective, but also from a professional perspective. I don’t know how I would summarise that free choice! Maybe travelling, broadening your horizons and really doing something that might be out of your comfort zone.
JM: Very good. I sometimes wonder why people should need to be told that but it is good advice. Good book choice as well. So thank you very much for those – and thanks for joining us today, Daniel.
DN: Thanks for having me, Julian.
JM: It was a pleasure. And thank you very much for watching. Do look out for further Choice Words videos as they are published.
