Driving out the benefits from a large and complex portfolio of projects is very difficult. In fact, for many portfolio leaders, making the right portfolio decisions can appear to be a dark art.
However, portfolio leaders are not alone in this challenge. Fund managers make investment decisions on large portfolios of financial products every day and as a result, are actually quite good at it. There is much we can learn from them.
We have identified five key techniques used by fund managers that can be applied to project portfolios. These five techniques – diversify, simplify, detach, speculate and reserve – can help you maximise the return on your portfolio of project investments.
1. Diversify – gain optimum return for a balanced risk: You’ve heard the saying ‘don’t put all your eggs in one basket’. Fund managers use portfolio theory to tell them exactly how many eggs to put in how many baskets. They ‘diversify’ by investing across industries, markets and geographies to ensure they are not over-exposed to any given risk factor.
As a portfolio leader, you should also consider the overall risks in your portfolios and avoid making isolated decisions on a project-by-project basis. Having a broad range of projects, dependent on a wide range of risk factors, is an effective way to manage delivery risk.
We helped a FTSE 100 utility company to transform their approach to IT Portfolio Management. By making visible the diverse range of IT projects they had to deliver across a federated organisation, we enabled them to make better informed investment decisions and more effectively manage risk across their £35m portfolio of IT projects.
2. Simplify – avoid extra complexity for no further gain: As effective as diversification can be for reducing portfolio risk, too much diversification can do more harm than good. Fund managers recognise a point beyond which the administrative burden associated with holding an additional stock outweighs the benefit. This is because each new stock added to a fund needs to be monitored, analysed and reported upon on an ongoing basis – increasing management effort of the overall portfolio.
Typically, the number of stocks where this starts to happen is 20-30 according to the Financial Times. See graph below.
While there is no ‘magic number’ of projects in a typical project portfolio, portfolio managers do need to be careful about how much they diversify and how. Too many projects in a portfolio can create a real management headache, including a number of critical challenges:
We helped a global FTSE 100 FMCG company simplify a complex portfolio of over 3000 projects. We helped the client identify where the scope of projects potentially overlapped or was duplicated and recommended approximately 10% of the portfolio be stopped. This identified resources which could be freed up, allowed better focus on the strategic outcomes and generally reduced the management burden of the portfolio.
3. Detach – remain objective at all points: Fund managers use a broad range of data to assess investments and inform portfolio decision making, in a way that is impartial and focused entirely on the investment strategy. As a portfolio leader, you’ll know it’s easy to lose this type of objectivity. It is possible to get attached to certain ‘pet projects’ or fall victim to ‘optimism bias’ - the tendency to overstate benefits and underestimate time and cost when it comes to planning project activities.
By making portfolio decisions objectively, you can avoid some potentially disastrous decisions. Some ways to do this are by:
We helped a FTSE 100 Leisure company’s IT function to develop their project portfolio approach, resulting in improved visibility and performance of the investments and also better alignment to strategic and operation priorities of the division.
4. Speculate – take calculated risks: Fund managers use financial products called derivatives to manage risk and return. These are essentially contracts for some future trade and were originally used by farmers to secure payment for grain in advance of sale. Since then, they’ve been used to speculate on changes in prices, and for some have been very lucrative.
Portfolio Managers can also speculate to reduce risk in the project portfolio, particularly in Innovation or R&D portfolios. For example, an organisation may have an opportunity to develop a new medical device, which may take several years to reach market. If the company speculates that competitors may also be working on the same type of product then it may wish to invest in the same type of product to ensure it doesn’t lose significant competitive advantage. If it doesn’t invest then although the development costs will have been saved, the potential market growth, revenue and profit opportunities will be lost – certainly in the medium term. Approaches such as these are often referred to as ‘real options’.
We have recently been working for another FTSE 100 consumer goods organisation who has been running a portfolio of innovation and product development projects within the same market category – on the understanding that not all of the projects will be successful – but at least one is expected to launch into market subject to successful consumer trials and feedback.
5. Reserve – ensure you keep a contingency: Fund managers tend to maintain a pool of money not tied up in any investments. In fact, the investor Warren Buffett argues that you should only invest when the time is right. When no suitably appealing investments exist, save instead.
Unfortunately project portfolios seldom manage to do this and tend to allocate 100% of the available resource from the outset. This means that when an opportunity presents itself, it’s not possible to exploit it. By retaining some spare capacity (e.g. budget, resource, capability), you can respond quickly to changing market and business needs and start new projects without the need to stop any existing activity.
Part of our work to help a FTSE 100 hotels group improve its approach to portfolio management included a revised portfolio funding model. The project portfolio funding model included a 10% discretionary fund overseen by the executive team. This allowed the organisation to respond to new opportunities as they arose, and get better value from the £100+ million portfolio.
Guarantee long-term value
Portfolio management is strategically critical, organisationally complex and often politically charged. Traditional approaches will only get you so far, so we recommend considering your portfolio through a number of ‘lenses’ to increase long-term value. The fund management lens is just one lens we help our clients use to help improve the performance of their project portfolio. By using the techniques we’ve identified, you can equal the success of some of the world’s best fund managers.