Merrill Lynch determined to keep calm and carry on

When it comes to portfolio management, the ‘man versus machine’ debate has been one of the most discussed in recent times. The question is to what extent the advancements in quantitative research and the sophistication of software can replace intuition or common sense?

“Asset allocation tools are useful but, they are exactly that, a tool, and should never be used in isolation,” states Simon Miles, head of discretionary at Merrill Lynch Wealth Management Emea. The US-based group runs $1,500bn (€1,040bn), but refuses to give regional breakdowns.

“The human element, the human experience is very important in the asset allocation and risk monitoring process,” says Mr Miles.

This mantra is especially true in today’s uncertain times. Tools do rely on the quality of input they take and the human element comes from people’s experience. “No two situations are exactly the same but history teaches you a lot in terms of how markets will react. Any investment process is always in evolution; nothing is set in stone,” he says.

The financial crisis was a particular “watershed”, for global markets and in terms of the way people reacted to them, he says, but today’s extremely volatile markets prove to be as difficult. “What we are living at the moment is one of the most challenging market environments I have even seen in my 25-year career.”

Current markets are significantly driven by macro-economy factors – investor sentiment is very extreme and changes very quickly, sending shockwaves though global financial markets. “Investors are very much polarised in terms of risk on, risk off attitude. They either want to add risk or they desperately trying to take risk off the table and those cycles are very quick. That’s why we are seeing such volatile markets,” he explains, adding that this is also one of the reasons why it is very difficult to make money at the moment.

Concerns about the US debt and the eurozone crisis have put investors into a “risk off” mode for most of the summer, during July and August. Before, people were feeling much more comfortable with having risk positions, which reflected in markets performance.

While strategic asset allocation sets the long-term goals and should not change over time, it is the tactical moves that respond to evolving views on markets and economies.

“Sometimes it is difficult to see what the actual catalyst and turning point is. What might be the catalyst for risk on is if the US decide to go ahead with its third round of quantitative easing. If that happens, people will want risk and will want to get into cyclical stocks and particularly resources,” predicts Mr Miles.

How they compare

• At Merrill Lynch Global Wealth Management, the advisory business, legacy of its past as a brokerage firm, born in the US and expanded internationally, makes up by far the largest part of ML’s assets under management.

• The discretionary side is much smaller. The bulk of discretionary portfolios start at $3m for a segregated, bespoke offering. However the minimum account size is $1m. In this case the portfolio would usually be a funded solution.

“Equities are looking reasonably good value at this level and over the next six to 12 months we believe they will produce better returns than cash or bond markets. I believe at some stage we will increase our tactical allocation to equities from a neutral position to overweight in the next few weeks.”

Investors looking on a medium-term basis should make sure they are close to their long-term strategic benchmark in equities, as this is the way they are going to combat some of the inflationary pressures that are eroding their spending power.

Large cap growth companies are paying good dividends, and the income component of an investment is very important to long-term returns. For example, considering the total and not just the capital returns, many shares on the FTSE 100 at the moment are yielding more than government bonds.

Industry wise, the healthcare sector looks attractive. And the expected improvement on the returns of the Chinese stock market will drive up the prices of resource stocks. “In terms of region, on a medium-term basis we would still emphasise the growth economies of the world, such as Asia and to some degree Latin America,” he says.

In this fast-changing financial and economic environment, information is absolutely key. “You do have to be more proactive. But we are in the long-term management game – we are not the hedge fund that is trying to trade on a daily or hourly basis,” explains Mr Miles.

“We may decide not to do very much, but does not mean we haven’t been considering where we should make those changes or not. Often it is a very clear decision to not sell something.”

The allocation calls today are a lot bigger than they used to be historically. That is a function of the fact that markets react so much quicker now. Data is that much more freely available and the reaction time is smaller. “You have to be more nimble than you used to be,” says Mr Miles. “Also, clients ask us to take conviction-type bets.”

Managing portfolios today is not just about managing money against a benchmark. The concept of a rigorous risk budget in portfolio management is now crucial. The improvement of risk controls and more sophisticated tools allow better insight into the way the portfolios are constructed and managed. It is now possible to measure the amount of risk each asset class adds to the portfolio and, within asset classes, which securities add more risk.

Therefore, sometimes, the bets are not so obvious or transparent as they may have been in the past. Towards the end of March 2009, based on attractive equity valuations, the decision was taken to increase risk within clients’ portfolios, remembers Mr Miles.

“We increased the equity component by 1 or 2 per cent but mainly we changed the nature of the equity portfolio, from a very defensive to a more cyclically oriented portfolio.” That was enough to increase risk substantially.

In this rapidly evolving market, it may be argued that managing accounts on a discretionary basis has its own advantages. In that particular instance, few of ML’s advisory wealthy clients actually went down the same route of adding risk by increasing the cyclical equity portfolio, although their advisers gave them the same recommendations.

It is certainly true that today all clients are very much involved in the management of their investments. The idea of giving ‘carte blanche’ to bankers belongs to the past. However, as advisory clients have to give their consent for any type of portfolio change, and many of the super rich lead very busy lives, it is not always possible to take advantage of market opportunities in a timely manner.

“The best way to manage a portfolio successfully is almost to do it in partnership with the client, so that you are working together to produce the best aims for them,” concludes Mr Miles. Studies have showed that the average private client buys at the top and sells at the bottom. It is not right to say that discretionary portfolio managers to the opposite, as they are humans as well, but taking emotion out of the decision making, over time, adds significant value, believes Mr Miles.

Today’s volatile markets really test the ability to keep calm. “There are times when you question whether you really got your strategy right, but that’s what makes the job so interesting and challenging,” he says.

CV

Simon Miles

Simon Miles is the head of Merrill Lynch Portfolio Managers (MLPM) in Europe, Middle East and Africa. He is based in London.

Mr Miles has 26 years experience in the industry and has built up extensive knowledge of the portfolio management of private clients. He began his career at Barclays before joining the SG Warburg investment management team, responsible for providing discretionary solutions to non UK clients, in 1983.

SG Warburg later became Mercury Asset Management, which was then acquired by Merrill Lynch in 1997. Mr Miles became the head of MLPM in September 2010.

Mr Miles is an Associate of The Chartered Institute for Securities and Investment.

Simon Miles, Merrill Lynch