Mo Haghbin - Customizing Solutions from the Top Down at Invesco (EP.390)

0:04Hello, I'm Ted Seides and this is Capital Allocators. This show is an open exploration of the people and process behind capital allocation. Through conversations with leaders in the money game, we learn how these holders of the keys to the kingdom allocate their time and their capital. You can join our mailing list and access premium content at CapitalAllocators.com. All opinions expressed by TED and podcast guests are solely their own opinions and do not reflect the opinion of capital allocators or their firms. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions.

0:44Clients of capital allocators or podcast guests may maintain positions in securities discussed on this podcast. My guest on today's sponsored insight is Mo Hagman, the head of multi-asset solutions at Invesco, where he develops and manages asset allocation strategies and portfolio solutions for$88 billion of client assets within the$1.7 trillion asset manager. Our conversation covers Mo's journey to finance and his path to a leadership role at Invesco. We discuss Invesco's solutions-based approach that canvases every type of asset pool and structure and focuses first on top-down strategic asset allocation and tactical positioning, and only later on manager selection.

1:30We cover the research that drives asset allocation and factor decisions, importance of scaling customized solutions, and impact of technology in the process. Before we get going, Capital Allocators has entered the world of AI. We've trained a large language model on all our transcripts to help you learn anything you want from seven years of conversations. We've affectionately called this model ChatGPTED. It's safe to say Hank Morgan and I have no idea how to build an LLM, train data, and get the outputs that ChatGPTED delivers. So a special thanks goes to our friends on the data science team at Adalia Capital, who took on the development of the minimum viable product from start to finish.

2:20What they've done for us barely scratches the surface on how they're using AI to enhance their investment process. But I'll leave that to you to discuss with them. Chat GP Ted is the latest add-on to our premium membership. To sign up for a premium membership and access Chat GP Ted to query all our transcripts, go to capitalallocators.com. Thanks so much for spreading the word about Chat GP Ted. Please enjoy my conversation with Mo Agben.

3:17and we started life in a very normal way, but things changed quickly. So we grew up during the revolution where the Shah had been essentially ousted and there was an Islamic revolution. So my parents very quickly decided with three young kids that they needed to change. And we moved to the US when I was in elementary school. So what was that schooling path like from there? We settled in Colorado, and I went to elementary school, middle school, high school, and actually college. I went to the University of Colorado Boulder, and I got a degree in finance. What's really interesting is my parents basically had to start all over.

3:58They couldn't carry forward those jobs that they had in Iran to the US. So my upbringing was very much unique in that we didn't have all of those structures in place for me and my brother and sister to really be successful. We had to learn a new process, learn a new system. So I put myself through school and learned along the way, I would say, because my parents weren't really there to give me that guidance because they were also learning what it was like to be an immigrant in the U.S. But yeah, so I graduated from the University of Colorado Boulder. I spent a few years in Colorado, and then I quickly moved to the West Coast and started my career in finance in San Francisco.

4:39So those aspects of learning when you were a kid, as you reflect back, what were the things you didn't know that you felt like other kids did? If we're talking about the financial services industry, so things like a 529 plan, a retirement account, FAFSA and filling out higher education, financial assistance, these are things that really were foreign concepts for someone coming to the US. So I had to learn those things. Also, the language barrier is actually a pretty big one. Learning English as a second language is much more challenging, I think, than you'd think. Like it's not just learning as a second language, as a hobby, but you have to in order to be successful in a new country that you call home.

5:23But I look at those years as really foundational years for me because I think I learned a lot about how things can change quickly, how to be adaptive, how to be flexible. I learned a lot about saving and investing because it was necessary to be able to go to school. So it was a really great experience for me. I don't really regret that. I actually think it was something that made me much better at my job, helped me with school, because those challenges really formed a strong character. What was it that drew you to finance? So actually, I didn't really know what I wanted to do. I found a role at an RIA in San Francisco that honestly was something that was more luck than really intentional at that point.

6:08And I basically packed up all my stuff and moved to San Francisco. And that, I think, really was a time where my understanding of finance was quite different. I couldn't have told you what an investment banking job was like or what an asset management job was like. So that was my first experience. Quickly from there, I got a job at Barclays Bank, which was probably what really shaped my career from there. I decided that I wanted to be more on the institutional side. The RIA channel was very heavy on client-facing activity, which I enjoyed, but I was more analytical and I tended to be more interested on the investment side.

6:50So the Barclays job really helped me get some of that experience that helps me today with my current job. As you roll forward from there to where you've come today, what were the formative lessons that shaped your path to Invesco? So I've been lucky in that I've had a lot of experience across various asset classes and types of roles. So I mentioned the RIA in San Francisco. At Barclays, I was more on the derivative side, pre-financial crisis, which ended up being a really interesting job, a front row seat to some pretty interesting things. From there, BGI was acquired by BlackRock and I moved into fixed income.

7:28And I spent many years in fixed income, both on the long-only institutional side, but also on the exchange-traded side. And then more recently, equity. So what I would say about my career is it's been really diverse. Every couple of years, I've been afforded an opportunity to do something new, which I think is very helpful if you sit in a multi-asset seat because you need a broad set of experiences and you're not investing in a single asset class. You're not picking securities or allocating capital. So you have to know a lot about a lot of things, but you don't need to know everything about a certain thing.

8:06What were those different roles that you played in each of those asset classes? So on the derivative side, I was supporting our hedge fund business. So BGI had a very large systematic hedge fund group, and I was supporting a lot of their exotic transactions, credit default swaps, total return swaps, inflation swaps, interest rate swaps. At the time, all of that was bespokely negotiated pre-financial crisis, there wasn't any standard mechanism to trade those things. So you'd get a document that was like a hundred pages long that you'd have to review in order to get confirmation with the counterparty that you actually had a trade.

8:42So that was the experience originally. Fixed income, very focused on credit and multi-sector. So the long only systematic group at BGI was really, really successful thinking about index-based concepts. So everything was methodologically driven, fully transparent, which was actually really interesting because I ended up moving into the ETF business, into the iShares group. And I spent many years working with index-based fixed income solutions. More recently on the equity side, applying some of those systematic approaches that I've learned in the past, but to a set of new asset classes. So within equities and more recently thinking about public, private, and multi-asset investing.

9:26So you arrive at Invesco. What is the lump sum of Invesco today? So Invesco manages about$1.7 trillion in assets for clients globally. Within the solutions group, we manage about$88 billion of assets. And that's pretty diverse across client type. We work with financial advisors, pension funds, endowments, foundations, insurance companies, sovereign wealth funds. So it's pretty diverse both from a client segmentation as well as a geography perspective. So you use the magic word solutions, which means a lot of things to a lot of different people. How do you define what the solutions group is? So I think it starts with really working backwards from the client.

10:08So within asset management, within our industry, we tend to think about things as products. We build a product and we sell a product. Solutions starts the exact opposite way. We have a conversation and then we map to a capability or make a capability, create a capability. So really it involves a lot of dialogue, understanding not just a particular asset class or a particular strategy, but understanding a particular problem for a client, and then working with our broader capabilities across the firm and sometimes even outside the firm to create the solution. So solution to a problem rather than product for a problem.

10:48When you think about the scale of$85,$90 billion, sometimes you think of the solution as this little niche gap in a portfolio. But at that scale, you're probably doing a lot of different things. So as you look across your business, how do you think about serving different clients and different solutions you're creating for them? It really depends. We have certain clients that are very fixed income heavy. So think about a pension fund that's in surplus. They're not really worried about generating additional returns. They're worried about immunizing or matching the cash flows or future liabilities.

11:26Take the other side of that. If you have an underfunded pension, well, they are looking for growth. They need to look for opportunities to get closer to their funding ratio. With sovereign wealth funds or other perpetual organizations, they tend to have really long horizons. So intraperiod or annual volatility is not as big of a concern. They can take a lot more risk and they're not worried about mark-to-market as much as other types of clients. Financial advisors have to manage relationships with their end clients. Their end clients could be very risk averse. We have to build a solution that meets those needs.

12:00Because we work with such a diverse set of clients, it really just depends on what the objectives are. We're generally benchmark aware, but I think what people don't understand is that understanding what that benchmark is, is really important and really hard sometimes. What is the goal? What's the objective? From there, we can apply our asset allocation techniques and try to deliver a performance result that's better than the benchmark, but it starts with the benchmark. So you have this widely dispersed range of needs and you're trying to create that benchmark and execute. What overriding investment philosophy do you bring to serve these clients?

12:39So the team is very much a top-down asset allocation team. And we think about asset allocation in a regime-based framework, so business cycle aware framework. Everything we do is geared towards understanding long-term return drivers, so strategic asset allocation decisions, and shorter-term return drivers. So think six months to three years, tactical asset allocation decisions. From there, it's really about how we implement, and we generally implement through managers. So we're selecting a manager within public equities to get the exposure that we're looking for in equities. We are selecting a manager in private credit to get exposure to direct lending or distressed credit.

13:24We're not directly investing in those markets. So that's the last piece of it is the portfolio construction and manager selection piece, which becomes really, really important because it's bringing the puzzle pieces together. It's a little bit art and science. You can't perfectly do that through your regular analytics reports and reports that you get from the systems. You have to really think about both the quantitative and qualitative aspects of what makes a manager successful and how that manager behaves with other managers in the portfolio. I'd love to dive into the implementation of that in those three-piece, say the strategic tactical and the manager selection.

14:03What inputs do you bring in that strategic asset allocation to form macro views that will help you understand where you want to invest tactically in with managers? Yeah. So great question. For strategic asset allocation, historically, what many firms have done and what we also do is think about capital market assumptions. So we're looking at essentially estimated risk and return for asset classes over a 10-year horizon. The problem with that is it's really hard to estimate what returns are to be expected from equities 10 years from now or what risk should be expected. So we take that approach and combine it with things that I think are a little bit easier to predict.

14:44What we're trying to understand is historically speaking, what structural long-term bets have been rewarded? I'll give you an example, value. Valuation is something that over the long-term we see has been rewarded. That doesn't mean that over three or five or seven or 10-year periods, it's going to be rewarded. And we've seen that. We've experienced that in the more recent times. But we think that's a long-term structural bet. So it's this combination of our expectations around asset class returns with what we have historically seen rewarded in market. What structural factors, whether they're behavioral or risk-based, have been rewarded by the market.

15:24So if you take equities as an example, you mentioned valuation, you could think of the basic factor assessment, quality, size. What are the levers that you'd like to pull in just say your equities portfolio? This is where we have spent a lot of time over the last few years, taking asset allocation frameworks and applying them within an asset class. So you mentioned equities. We, like everyone else, noticed that it was increasingly difficult to add value to drive alpha within parts of the equity portfolio. So think large cap US equities, very difficult to add excess returns. And we had a problem.

16:06We had a very large part of the portfolio allocated there. It's actually the largest for most clients, but it was harder to generate returns beyond the broad-based indices. And we developed something that I think is quite innovative. We started out thinking about asset allocation decisions. We use a regime-based framework. So we understand economic growth and changes in economic growth and the sensitivity of asset classes to those changes. So what are cyclical assets or what are counter-cyclical assets? And then we said, okay, what if we just took that same framework and applied it within equities?

16:44Are there factors or sectors that also behave that way? And what we found is the answer is yes. So things like size and value tend to be more pro-cyclical. Things like quality and low volatility tend to be counter-cyclical. They're more defensive. And are we able to actually systematically harvest those style preferences using a business cycle framework. And in 2017, we partnered with FTSE Russell, we created a suite of indices, and we started allocating based on historically rewarded factors during stages of a business cycle. So think of recovery, expansion, slowdowns, and contractions. How should we overweight or underweight factors to get potentially the best possible outcome in the shorter period.

17:28We know over the long term, structurally allocating to factors are rewarded. But most CIOs, most people sitting in portfolio management seats don't have 20 years. They have to also generate returns over three, five, seven, and 10-year horizons to keep their jobs. So we felt like it was very important to think about equities a slightly different way. And we use the products within our own portfolio. you. There's this marriage that you're describing between strategic asset allocation and tactical allocation. So on the strategic side, let's just say value works. If you have a 25-year horizon, nobody has a 25-year horizon, you better figure out what to do in the middle.

18:08How do you bring those together to figure out where you are in a regime? If you think about factor investing, the starting point is be overweight all factors equally because their excess returns are negatively correlated and over time, you will get the benefit of diversification. We agree with that. There's nothing wrong with that approach. But we also understand that over shorter horizons, taking views on factors, taking views on certain styles can be beneficial. So if your benchmark is the broad market cap, your long-term position is a overweight to certain rewarded factors. Your tactical position is how do you adjust that overweight given what's happening in the market today?

18:49How should I tilt my portfolio away from both my benchmark and a neutral overweight factor portfolio to harvest potentially excess returns over a shorter horizon? If you look at equities today, how are you thinking about the next few years? So our models generally tend to change two to three times a year. So they are pretty dynamic. I would call them low-frequency quantitative strategies. If I look at our current positioning, it tends to be a bit more pro-cyclical. We tend to favor smaller and middle capitalization companies, value-oriented companies, because what we're seeing from the economy is actually quite impressive.

19:31It's been very resilient. Most people expected a recession by now. We haven't had a recession. Employment is very stable. The consumer is pretty healthy. Generally speaking, in periods of economic expansion and recovery, factors and sectors that have higher operating leverage and more beta to the market tend to outperform. So that's how we're positioned. But we can review that on a monthly basis. So if something changes, we reserve the right to also change. So it's a little bit more of a dynamic approach to thinking about it. And what I find quite interesting, we used to do asset allocation studies for clients every two to three years.

20:08Now, imagine if you haven't done an asset allocation study for two to three years. Interest rates have moved from zero to five and a half percent. The world is completely different. And if you haven't changed your asset allocation, you're probably missing something. I believe that given the importance of equities within the portfolio and alternatives and other strategies have been very popular, but equities is still the largest allocation in the portfolio. Thinking about that allocation in a more dynamic fashion, given the speed at which things change is becoming more important. So that set of decision factors of what's happening in the economy that's leading you to be pro-cyclical, there are other people that might look at it and say, well, the same set of factors would tell me to be contrarian.

20:52The market thinks rates are coming down. That's good. Well, maybe now's the time to be more cautious. How do you get from looking at the set of factors to making the decision about where you want to bring your client portfolios? The way we're talking about this is very conversational, very casual. It's much harder than the way we're having this conversation. We take all the emotion out of it. That's the first step. We aren't waking up every day and saying, how do we feel about the market? We build models. So we have a model for a leading economic indicator, basically trying to understand through the data, whether the economy is growing above or below its long-term trend.

21:32We also have a model for risk appetite. This basically measures in aggregate what capital market participants are experiencing as they move out on the risk curve. Those two models combined tell us a little bit about how we should position across the factor set. So if leading economic indicators suggest that the economy is growing above its long-term trend and risk appetite is accelerating, that's a pretty healthy environment for risk assets. That's an expansionary environment. And we're going to favor small and mid-cap stocks and maybe momentum because there's a clear trend with growth. Conversely, if our leading economic indicators are showing that growth is below trend and decelerating, that's generally a sign of a contraction.

22:21So we would then get more defensive in the portfolio. We would upweight higher quality, larger companies, lower volatility companies. All of that is systematically done. There is no discretion per se. The discretion is how we build the models, how we think about the world. But then as we implement the portfolio, we try to remove the emotion. We try to remove the day-to-day biases. We are all subjected to a lot of information. You wake up in the morning and the news flow dominates your day. We don't want that creeping into the portfolio. So if you look at this two-by-two matrix effectively of where you are on risk appetite and the strength of the economy, you mentioned positive-positive and negative-negative.

23:05How do you think about the other two? So economy strengthening, but risk appetite is decreasing or economy softening, risk appetite is increasing. In that two-by-two, you're talking about recoveries and slowdowns. So slowdown is where growth is above its historical average, but the market is telling us that sentiment is shifting. So in those periods, we would still be a bit more defensive. Where we would introduce momentum is really at those cyclical peaks and troughs. So what I mean by that is we generally wouldn't want to be in momentum when there's a sharp reversal. It tends to have really bad reversals.

23:44So those factor exposures are actually preset. We're not sitting around debating whether or not we like size or value today. They're preset based on where we are across those four regimes. So if we move past equities, let's turn to fixed income. How do you apply this tactical asset allocation lens in the fixed income market? With fixed income, the factors that drive the majority of the returns are different. So you can explain most of the return in fixed income looking at interest rate sensitivity and credit exposure. If you have international, then FX would also be in there. But the same applies when we think about allocating capital to fixed income.

24:25What is the duration profile of our benchmark? Where are we relative to that? What is the credit risk of the benchmark? Where are we relative to that? So it's all relative to benchmark. And if we are more defensive, then we might be adding interest rate risk or adding the sensitivity to duration. So getting longer duration. If we are more optimistic, we might be increasing the credit risk of the portfolio. Similarly in fixed income, how do you think about changing your duration or turnover of changing the posturing in the portfolio? So it depends on how we would implement. In a lot of our allocation products, what we like to do is not move the managers.

25:07So remember, we are not picking securities, we're picking managers. And changing managers can be actually quite cumbersome. It could actually lead, if it's a taxable account, to a tax event. So we try to take that tactical view and overlay space when possible. So think about adding duration using treasury futures. Think about adding credit or subtracting credit risk using CDX. Now, in equities and fixed income, the levers are reasonably known in terms of the drivers of return. You get into some of the alternative categories. Some of it is a little harder to put your finger on what's going to move the needle.

25:46So how do you think about that structure, applying it to alternatives? I think the challenge in alternatives is that you actually can't really be that dynamic. You can talk about the marginal dollar, but the invested capital tends to be long-term. When we think about assets on the alt side, it tends to be more about where we want exposure for the strategic time horizon rather than the tactical time horizon, unless we have new capital to put to work, in which case then we try to understand where we are in the business cycle. So there may be certain asset classes that tend to perform better in early stages of an upswing and certain asset classes that tend to perform better in the early stages of a downswing or in a prolonged contractionary environment.

26:31There, I think the liquidity is going to be the key factor. Are you able to raise cash or move between asset classes or not? The answer is generally not. So we tend to keep that portion of the portfolio fairly static. As you look at return composition, what have you found are the biggest drivers? So I think as an industry, we spend a lot of time thinking about the bottoms up piece, idiosyncratic piece, but the majority of your return comes from your top-down asset allocation decisions. So think about really simply, if you're underweight equities over a prolonged period of time, irrespective of how you sourced that equity exposure, you're probably going to be underperforming your benchmark.

27:18If your benchmark is 60-40 and you have a structural underweight of 10 % over a 20-year horizon. You have to do a really amazing job picking managers and thinking about style exposures. Very difficult to overcome the fact that you're underweight equity risk. So the majority of the returns are going to come from your asset allocation decision. I would argue an equal, maybe not exactly equal, but pretty close is going to come from your style decisions. And the rest is going to come from idiosyncratic. But we've spent all of our time talking about that piece, which I find really fascinating. What have you found about the predictability of the asset allocation and the tactical decisions compared to the manager selection decisions?