Tom Clarke, portfolio manager on William Blair’s Dynamic Allocation Strategies team, discussed how the team seeks to manage macro risks through active currency exposures, dynamic risk allocations, and game theory analysis in an interview with Advisor Perspectives.
The investment team’s significant allocation to active currency management is a key differentiator and seeks to provide low correlation to the rest of the portfolio, Clarke told Advisor Perspectives. The portfolio’s investment universe includes developed and emerging equity, fixed income and credit, and currency. The portfolio can invest in up to 33 currencies and, currently, has about 20 long and short active currency exposures.
“We don’t target a single level of risk and keep the portfolio at that level, come what may. Sometimes it can be quite a bit lower, as it is now, and other times, like in 2012 and 2013, we’ll take the risk level up.”
– Tom Clarke, portfolio manager, William Blair Dynamic Allocation Strategies Team
Clarke also highlighted the team’s dynamic use of risk budgets, where the portfolio actively takes more or less risk depending on the opportunities. The portfolio has a 10 percent expected average volatility over the long term.
“But we don’t target a single level of risk and keep the portfolio at that level, come what may,” Clarke said in the interview. “Sometimes it can be quite a bit lower, as it is now, and other times, like in 2012 and 2013, we’ll take the risk level up.”
He added that the risk level depends on whether geopolitical and macro-thematic influences are pushing prices in the same or opposite direction of where fundamental valuation is pulling prices.
Clarke went on to tell Advisor Perspectives that the team first uses fundamental analysis to identify value/price discrepancies. But it’s in the second step of their investment process, where the team uses game theory to better understand and navigate the geopolitical risks and macro-thematic influences that affect market prices and currency rates.
Geopolitical events are multiplayer, strategic negotiations, he explained. Game theory analysis examines who the players are, their objectives, and whether those objectives are aligned or in conflict with the other players. The team also assesses who the most powerful player is based on several bargaining powers.
This provides the team a framework to better understand the risks, the potential outcomes, and the investment implications of key geopolitical events.
Clarke went on to provide an example of how the investment team used game theory to analyze the Brexit vote:
- Two players: Stay and Leave camps
- The players had directly opposing objectives
- Opinion polls provided best gauge of relative power – very close polls meant players had equal power
- Players with opposing objectives and almost equal power resulted in a mutual incentive to deliberately raise the stakes and increase risks
“So there was a meaningful high probability of an outcome with less free movement of labor, goods, services, and capital—all of which are textbook growth negatives,” Clarke said.
As a result of this analysis, the investment team went into the June 2016 Brexit referendum with a much reduced but long U.K. equity position (U.K. equities were fundamentally attractive), and a bigger short U.K. pound position (the team viewed the currency as fundamentally unattractive).
Clarke also highlighted where the investment team believes the best opportunities exist around the globe:
- European equities and emerging currencies (although macro-thematic influences are currently not making these opportunities as compelling as they could be)
- Some equity sectors, such as energy and utilities, are becoming more attractive (commodity prices have fallen a long way and have stabilized in the last several months)
- Frontier equity markets are emerging as an opportunity (these markets are typically uncorrelated with the overall market, which the team finds attractive)
- Relative-value exposures that are not long or short the market (e.g., short Mexican equities and South African equities while long other emerging equities that are attractive)
Standard Deviation (Expected Volatility): A measure of the portfolio’s risk. A higher standard deviation represents a greater dispersion of returns, and thus a greater amount of risk. The annualized standard deviation is calculated using monthly returns.