Formula One to Finance: A Journey in Market Mechanics

Paul Morris, a portfolio manager at Milford Asset Management, took an unconventional path into finance. After completing an aeronautical engineering degree, as a potential gateway into Formula One design, he has ended up managing multi-asset portfolios. An analytical approach, not dissimilar to strengths needed in engineering, helps to guide his understanding of global market dynamics. We talk to Morris about his current role at Milford, insights into market structures, the lasting effects of quantitative easing, navigating geopolitical risks and managing volatility in today’s unpredictable financial landscape.

Before we delve into macroeconomics and OCR shifts, could you explain how you transitioned from aeronautical engineering into the financial markets?

Aeronautical engineering was a degree I chose because of my interest in aerodynamics, particularly in Formula One. My initial ambition was to become a Formula One aerodynamicist, but I realised that, while I was moderately competent at engineering, my true strengths likely lay elsewhere. So, when it came time to seek employment, I cast the net reasonably wide. I ultimately secured an opportunity with a bank in the City of London on their graduate trainee scheme. This was a gateway into a variety of roles within the financial sector over many years. Interestingly, especially in the UK and the US, many of the people I’ve worked with did not study accounting or business. Instead, their backgrounds were often in physics, math, or engineering. It’s a reminder that your undergraduate or even postgraduate degree doesn’t necessarily dictate where you’ll end up in your career. In fact, having a team with a diverse educational background can be quite advantageous, particularly in investment management.

Did you find that you brought quantitative strengths from your engineering background to finance? 

Absolutely. You tend to gravitate towards what’s familiar. When I was a graduate trainee on a foreign exchange trading desk, technical analysis (a range of techniques used to forecast future prices based on historical price movements and patterns) felt like a natural comfort zone for me to base trading decisions on. Over time, however, I realised that relying solely on technical analysis was somewhat myopic. But as my career progressed and I moved into more complex financial market areas like interest rate derivatives I found myself returning to relying again on the quantitative strengths developed during my degree. By the mid-2000s though, I recognised that this wouldn’t be a preferred long-term career area for me, so I moved into credit trading, structuring, and eventually here in New Zealand into asset allocation and management of fixed-income portfolios. Now, at Milford, my focus has evolved further into multi-asset investing across fixed income and equities.

It seems there’s a significant focus on technical and fundamental aspects to your role. Has the balance between these approaches shifted over time?

The structure of markets across rates, equities, and FX has evolved significantly, so it’s crucial to be aware of both fundamental (i.e. economics, earnings, etc.) and technical factors driving a market. Early in my career, technical analysis relied on less sophisticated tools like using trend lines and moving averages etc., but this has since evolved into far more sophisticated algorithms. Fundamental analysis clearly matters and predominates our discussions, but you must also consider market technicals, such as market flows in and out of asset classes and where investor positioning sits. Essentially, it’s vital to remain objective and open-minded about what’s driving markets. For example, at Milford, we use scorecards to help determine our view of different asset classes. These scorecards take into account factors including the economic outlook (impacting company earnings and interest rates), bond and equity valuations, market positioning, monetary and fiscal policy, and known and potential unknown market risks. This helps us build a baseline for our market return expectations.

How do you manage risk within this framework?

Managing risk is central to our approach at Milford. We employ a variety of tools, including options, to manage downside (when prices fall) and upside risks. For example, we often buy broad market index put options, like S&P or NASDAQ puts, when volatility is being priced cheap (making these options cheap). This strategy allows us to protect the downside while still capturing the upside if the market moves higher. For us it is about remaining objective on what is happening in markets, managing risk appropriately to achieve each fund’s return objective in the context of its outlined risk tolerance. 

Given the complexities of today’s financial markets, how do you balance non-fundamental and fundamental analysis?

It’s a balance. While fundamental market valuations and drivers are very important, markets can remain irrational for longer than one might anticipate. Our job is to build a picture of what’s driving markets and manage to this, aware of the risks. Non-fundamental analysis indicators like moving averages, market flows, and market positioning are important technical considerations. But when making investment decisions we must always remain guided by fundamentals, such as fiscal and monetary policy and the economic and company earnings outlook. This holistic approach helps us stay flexible and responsive to changes in market dynamics.

Are there specific market cycles or periods that you find particularly challenging or fascinating?

The period of quantitative easing following the financial crisis and furthermore during the COVID-19 pandemic has been particularly fascinating. There’s been a significant increase in the monetary base (essentially more money has been created), and although central banks are now reducing liquidity (i.e. trying to reverse this) through quantitative tightening, the long-term impact of their massive monetary stimulus is still not fully understood. We’re still learning how these changes have and still are influencing asset prices. Navigating this requires ongoing analysis of both the short-term and long-term effects of these central bank policies on markets.

With your engineering background, do you see any parallels between designing a Formula One car and managing financial markets?

Designing Formula One cars is about precision but also optimising performance in the face of myriad variables within a given set of rules. This has some similarities to funds management. In funds management, you’re also dealing with a set of rules and a set of constantly changing variables. Each fund has a stated return objective and a set of investment constraints within which it must be managed. This means the fund manager has to navigate market conditions to optimise returns while managing risk within set constraints. In both fields, your analysis is trying to anticipate but also adapt to changes in these variables. For funds management specifically, you try to stay ahead of market shifts and adjust your strategies accordingly.

With all the volatility and market complexities, do you find yourself constantly analysing market opportunities, even outside of work hours?

It’s hard not to. The fund I am responsible for is the Diversified Income Fund which is focused on medium-term absolute returns. There’s always a balance between looking for opportunities and assessing potential threats. Like many in the industry, we spend a lot of time considering what could go wrong and how to protect against those scenarios. Financial markets are complex, and it’s essential to remain vigilant about both the known and unknown risks. It’s a continuous process of analysis and adaptation.

Given the current market conditions, how do you view the impact of geopolitical tensions on different share markets, such as the NZX versus the US or the UK?

Geopolitical tensions undoubtedly have a market impact, but markets are complex and can sometimes behave counterintuitively. For example, despite ongoing conflicts like Russia-Ukraine and tensions in the Middle East, we’ve seen equity markets continue to rise. Indeed one might have expected, under these circumstances, that oil prices would skyrocket, yet they’ve actually fallen as other price drivers have been more powerful. Once markets are aware of a risk, they can generally assess it, and put a probability around potential outcomes. It is important to acknowledge, however, that these tensions do add to uncertainty which may well still have market impacts to varying degrees. But known risks are generally easier for markets to deal with.

Are there particular asset allocation strategies you can employ to navigate this uncertainty?

Absolutely. When dealing with uncertainty, such as geopolitical tensions, we aim to remain objective and flexible. One of the strategies we use at Milford is to maintain a shifting balance between defensive assets and growth assets. Defensive assets include bonds (fixed income), cash, and to an extent income-oriented stocks. They tend to perform well even when economic conditions or the risk environment are more challenging. Income-oriented stocks often belong to companies providing essential services, so their performance is less tied to the economic cycle. In contrast, growth assets or other equities offer potential upside but can come with higher risk. By maintaining a diversified portfolio, we aim to mitigate the impact of geopolitical and economic uncertainties. As I mentioned earlier, we can also use broad market index put options, especially when volatility is cheap, which allows us to protect the downside. These put options increase in value when market prices fall.

How do you perceive the legacy of quantitative easing and its effects on market liquidity and valuation?

The legacy of quantitative easing is still unfolding, and its long-term effects on market liquidity and valuation remain to be fully understood. What we do know is that quantitative easing has led to a significant increase in the monetary base, which has likely had an upward effect on many asset prices. Even as central banks begin to unwind these policies through quantitative tightening, the market remains flush with liquidity (i.e. cash) such was their extent. This creates a complex environment where traditional valuation metrics might be more challenged, at least for a time, so market participants need to remain adaptable but vigilant.

As a final note, what advice would you give to those navigating today’s financial markets?

The key to navigating today’s financial markets is to remain objective, disciplined, and adaptable. Fundamentals do still matter, but so too does an awareness of other market dynamics, including technical factors. It’s crucial to have a robust risk management strategy in place to protect against downside risks while positioning oneself to take advantage of opportunities. Ultimately, staying informed, continuously learning, and being willing to adjust strategies as conditions change are essential to long-term success. I would add for those starting off that it is essential to understand both your risk tolerance and your return objective, and ensure these are realistic and attainable, while not letting market momentum lead to irrational decisions.