John Husselbee

How our strategic asset allocation is changing

John Husselbee

Key points from our 2018 strategic asset allocation review

  • Strategic asset allocation is designed to achieve long-term goals rather than reflect short-term market shifts
  • Equity allocations have remained static but there have been changes within this, with falls in expensive UK and US equities and increased weightings in Europe and Asia
  • These changes chime with our current tactical thinking, where we are favouring European, Japanese, Asian and Emerging Market equities

 

A key part of our Multi-Asset investment process at Liontrust is understanding the fact that successful fund management combines elements of both art and science.

Our portfolios are target risk and designed to achieve two main aims: the first is to target the outcome expected by investors in terms of the level of risk, as measured by volatility; the second is to maximise the return for each portfolio within these risk parameters.

We have a clear scientific element in the form of our strategic asset allocation (SAA), which is essentially our line in the sand, the default allocation should we have no views on the relative attractiveness of asset classes. The tactical overlay on top of this and how we select the funds to express our various views is the ‘art’ side of the equation.

Our Head of Risk Ed Catton leads the scientific part of the process and in constructing the SAA, he assumes the long-term historic return characteristics of each asset class are a reasonable expectation for future behaviour. On an annual basis, we collate and analyse the historical returns and volatilities of a range of asset classes, as well as their correlations with each other, to determine the best SAA for each model portfolio in order to meet volatility targets over the long-term. 

Catton has recently completed the SAA work for 2018, resulting in fresh numbers, but we are not rushing to reach target allocations. Our strategy is always to focus on cheaper assets – never veering away from buy low, sell high – and we will look to take advantage of any corrections.

Our annual SAA review serves as a prompt to ask ourselves if we were building a range of target risk portfolios with a clean sheet of paper, would we build them in the exact same way. This contemplates the changing state of markets, risk, interest rates and other factors that influence returns. It also challenges us to avoid becoming too comfortable with the strong equity returns and low volatility of the recent past.

The key thing to understand is that the SAA is designed to achieve long-term goals rather than reflect short-term market shifts. Broad correlations between asset classes tend not to change – equities are higher risk than bonds, for example – so if our underlying assumptions are correct, our SAA is unlikely to change much year on year.

What we do get each year is more information on correlations and volatility data and we continue to evolve the SAA in line with these.

Catton produces low, medium and high-risk SAA figures, equating to portfolios 3, 6 and 8 in our 1-10 range of risk profiles.

In 2017, the most significant change was in the low-risk SAA, where the equity allocation increased by 10 percentage points, from 27.5% to 37.5%. There is nothing as eye-catching this year, with the equity proportion in the low-risk SAA rising to 38.75% and bonds dropping from 60.5% to 59.25%.

On the medium- and high-risk SAA, equity allocations remain static at 80% and 98% respectively but there has been movement within this, with drops in expensive UK and US equities and higher weightings in Europe and Asia.

Bond allocations remain largely unchanged, with a slight fall in developed market government debt and a rise in high yield (the latter on the medium-risk SAA). The medium-risk allocation also sees a decline in the hedge fund weighting: many of these vehicles have underperformed the rest of the market and failed to meet their primary purpose of generating positive absolute returns.

It is important to reiterate these are not tactical shifts but rather how the data dictate we can best achieve the volatility targets.

These SAA changes do chime with our current tactical thinking, however: we rate every asset class from one to five, with five the most attractive, and currently only have European, Japanese, Asian and Emerging Market equities plus hedge funds/absolute return strategies and high yield ranked four or five. UK and US equities are ranked two, alongside developed market government debt, inflation linked bonds, property and commodities.

Looking at our current portfolios through the sphere of our updated SAA, the mid and higher-risk portfolios look light in Europe and Asia and heavy in the UK and US, suggesting possible trades if valuations are attractive and opportunities arise. 


Key Risks & Disclaimer

Please remember that past performance is not a guide to future performance and the value of an investment and any income generated from them can fall as well as rise and is not guaranteed, therefore you may not get back the amount originally invested and potentially risk total loss of capital.

This content should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Examples of stocks are provided for general information only to demonstrate our investment philosophy.  It contains information and analysis that is believed to be accurate at the time of publication, but is subject to change without notice. Whilst care has been taken in compiling the content of this document, no representation or warranty, express or implied, is made by Liontrust as to its accuracy or completeness, including for external sources (which may have been used) which have not been verified. It should not be copied, faxed, reproduced, divulged or distributed, in whole or in part, without the express written consent of Liontrust.

Tuesday, May 1, 2018, 10:27 AM