Family offices and classic institutional investors have been intensively involved in the field of alternative investments for years. Markus Hill* spoke on behalf of FUNDBOUTIQUES.COM with Martin Dürr, FAROS Fiduciary Management AG, about the challenges for asset management consultants in the selection of liquid and non-liquid investments in the area of real assets. Topics like, the use of mutual funds in this segment, investment process, capital market analysis, and manager selection will be discussed. Additionally, areas such as fiduciary management, consulting, and fund management (“implemented consulting”) as well as current challenges in asset management too. The importance of Borussia Dortmund and “A Brief History of Humanity” will complement the technical explanations.
Hill: What does FAROS do?
Dürr: FAROS deals with the entire process of capital investment by institutional investors. From the strategic allocation considering the liability side, over the tactical orientation to the concrete implementation of the investments – i.e. the selection of managers and funds. Also accompanying processes such as risk management, regulatory reporting, ESG strategy are part of the process.
Hill: What topics do you personally deal with in the company? How did you get into the consulting area?
Dürr: In my career, I have always switched between the investor and the consultant side, so I know both perspectives well. This has given me a very broad base and a good overview of the various facets of capital investment. During my time with one of the leading German family offices, I became involved with alternative investments quite early on. Even today my field of activity is still very broad. From capital market research in general to the special focus on alternatives, in particular the topic of infrastructure in the selection of managers and products. I started at dit, the investment company of the former Dresdner Bank, as an equity portfolio manager at the turn of the millennium. Then I switched to the consultant FERI Institutional Management to get to know not just one but many, especially international investment managers and their processes. At FERI, I was responsible for the further development of the manager selection department. Finally, I changed to the investor side, Munich Re and Harald Quandt Holding – for more than 10 years now working on the consultant side with FAROS.
Hill: You said that you also know the portfolio management area from practical experience. You have launched a mutual fund at FAROS. Why did you decide to do this?
Dürr: The mutual fund has developed from the cooperation with customers of fiduciary management. The liquid portfolio of this fund consisted of listed real assets, which we created as part of a “Best Ideas” portfolio. In terms of performance, the fund was convincing across the board – and the use case was also convincing thanks to the flexible and simple “exposure” to an attractive asset class. We, therefore, assumed that many investors must be interested in our allocation and selection service, especially as it was being offered at a reasonable price.
Hill: What is the investment process of your fund?
Dürr: First of all, the investment process is a top-down process: Based on our market assessment, our insights into existing investments in private market funds, and discussions with their managers, we decide on the allocation by region and sector. The cells of the resulting matrix are then filled by bottom-up selection. This means that the entire universe of potential investments is first qualitatively examined to determine the extent to which it meets our ESG and profitability criteria. The profitability criteria focus on the actual ownership of assets. Besides, the companies should have moderate leverage and not too aggressive capital growth. Concerning our ESG criteria, we generally exclude companies that are conspicuous, for example, by child labor, production of outlawed weapons, or corruption. The remaining companies are rated with an MSCI ESG score and must achieve a minimum score to be eligible for investment. Besides, the companies are then selected quantitatively according to the criteria of the highest stability in terms of dividends and generation of free cash flows.
Hill: What are the challenges in the area of liquid versus non-liquid investments? How important are risk management and volatility?
Dürr: In the case of non-liquids, for example, direct investments or private market funds, the challenge is the enormous inflexibility. It takes a long time – namely several years – before the desired exposure can be built up. It takes just as long to change the orientation of an existing exposure. Moreover, because of the blind pool risk, such a control is often imprecise. Last but not least, the required minimum investment of five million euros or more is also a considerable obstacle. It is very challenging to be able to construct a well-diversified portfolio by sectors and regions at this limit. These problems can be addressed and solved very well with liquid investments. There again the challenge lies in the higher volatility. Since I have the freedom to buy or sell the investment at any time, I also have a price at any time. In the case of private market funds, I only get it once a quarter – firstly, usually with a considerable delay of six weeks or more, and secondly, it is only an estimate. Whether I could sell my investment at this price is up in the stars. In the long term, liquid and illiquid investments are on par in terms of performance, but the short-term volatility of liquid assets is of course a challenge for some investors. We counter this with a so-called equity tail risk hedge. This means that we acquire put options on stock indices for part of our earnings. These options are relatively far out of the money, around 10 to 15 percent. This means that these puts normally expire worthlessly. If, however, the market falls sharply by 10 percent or more, the options go into the money and the portfolio is partially hedged. We always invest a constant amount, namely 10 basis points per month. Depending on the market environment, we can buy more or less hedging for this. If volatility is high, typically after periods of stress, we tend to buy less. At low volatility, i.e. in calm markets, rather more. This then also adds an anti-cyclical component to the hedge. Also, we hedge the portfolio against currency fluctuations – incidentally, something that can only be done sensibly with a liquid portfolio.
Hill: Asset management consultant and fund manager at the same time, does that go together?
Dürr: It fits perfectly. Fiduciary management, i.e. in principle comprehensive asset management for institutional investors, which is offered by many consultants worldwide, is also known as “implemented consulting”. The expertise and analyses required for asset management are the same as those used in consulting. FAROS Listed Real Assets (Ampega) implements the insights gained in capital market analysis and manager selection in our day-to-day consulting practice. Moreover, our target investments themselves are mostly portfolios of assets, similar to a fund. We, therefore, analyze them primarily through the eyes of the fund selector rather than the stock picker, thus bringing our core competence as an investment consultant to bear. And last but not least, there are no conflicts of interest: we can communicate transparently to our clients at all times, and the target clients for the fund hardly overlap with the advisory clients.
Hill: Where do you currently see the challenges for consultants in your segment?
Dürr: The challenges are always varied. At the moment, however, the continuing decline in returns is at the top of the list. It is not only the interest rates on government bonds that are at rock bottom but in all other areas, where ultimately there are always excess returns earned above the risk-free interest rate, returns are falling accordingly. This is also true for real assets. A particular challenge is to make it clear to institutional investors that despite all the potential for optimization on the asset side, i.e. the investment portfolio, there is of course also a corresponding and sufficient response on the liabilities side, i.e. in terms of the promised returns to customers or insured persons. The same returns as in the past can only be achieved with higher risks or, expressed the other way round: those who cannot or do not want to take higher risks must accept lower returns.
Hill: As is well known, the world is not just about asset management. Are there other fields where you are looking for a contrast?
Dürr: Absolutely. Anyway, I’m not someone who watches the prices every second on the Bloomberg screen. Sometimes I am all day long immersed in analyses and only get a delayed impression of the capers that the market is beating again. But it’s good for our portfolio, our added value lies in a stable long-term allocation and the careful selection of stocks. Short-term trading is not our thing. I am also notorious among my colleagues for my passion for soccer. When Borussia Dortmund plays, the markets can do whatever they want, I don’t have the time. Apart from that, I like to spend my free time dealing with scientific topics, reading books on them, such as Yuval Noah Harari’s “A Brief History of Mankind” and my all-time favorite is “The Selfish Gene” by Dawkins.
Hill: Thank you very much for the interview.
FAROS Fiduciary Management AG: https://faros-consulting.de
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