John Husselbee

Our 2020 Strategic Asset Allocation review

John Husselbee

The key points from our 2020 strategic asset allocation (SAA) review are:

  • The SAA is designed to achieve long-term goals rather than reflect short-term market shifts.
  • Our latest SAA review was done pre-Covid 19 and therefore continues to reflect the largely lower volatility environment of recent years.
  • Overall allocations to equities, bonds and alternatives have remained broadly static but there have been changes within this, with reductions in expensive and underperforming UK equities and increased weightings to Europe and Japan.

 

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

We have a clear scientific element in the form of our SAA, which is designed to enable each portfolio to achieve the level of risk intended. 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 move too much year on year.

What we do get is more information on correlations and volatility data and we continue to evolve the SAA in line with these. Working with Liontrust’s risk team, 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 to meet its volatility target over the long term.

Writing about our 2020 SAA update is interesting in that we largely did the work before the full implications of Covid-19 became clear and the numbers therefore continue to reflect the lower volatility of recent years. Volatility has been lower than long-term averages, depressed by the quantitative easing that began in the wake of the global financial crisis and has continued, in one form or another, ever since. Expected long-term volatility (based on 10 years) for our Risk Grade 8 portfolio is between 17% and 19%, for example, but as the chart shows, we would only have hit that level in one three-year period going back to 2002, the height of the financial crisis from 2008 to 2010.

Liontrust Multi-Asset Annualised Volatility

Source: Liontrust, 2020

More recently, we have seen volatility gradually moving back towards longer-term averages and there has been a recent rise in the wake of Covid-19. While this may mean further changes to our SAA when we review the position next year, we would still not expect anything too substantial as we continue to use long-term data.

While volatility has been lower over the last decade, we are not tempted to chase either risk or the market itself, both of which can lead to a risk spike in the short term and potentially higher drawdowns. As our investors will know, our process is built on the foundations of winning by not losing over the long term by focusing on downside limitation before upside generation and chasing risk obviously runs counter to this strategy.

Whenever we discuss SAA, it is important to reiterate any moves are not tactical shifts but rather how the data dictate we can best achieve our volatility targets: the changes reflect underlying shifts in the risk and return profiles of all these asset classes. Recent market upheavals due to Covid-19 provide a good opportunity for us to highlight exactly what SAA is and, just as importantly, what it is not, particularly relative to peers who move their strategic allocation around more aggressively.

The SAA is our allocation should we have no views on the relative attractiveness of asset classes, the middle lane of the motorway if you will, and now is not the time to be changing that substantially: we have chosen our route to get to our ultimate investment destination. Where we can add value and take advantage of cheaper valuations is via our tactical asset allocation, and how we select funds to implement our views. This is where we can move into the fast lane in certain areas, to continue our analogy.

For the latest SAA review, we produce low, medium and high-risk SAA allocations, equating to portfolios 3, 6 and 8 in our 1-10 range of risk profiles.

Liontrust Multi-Asset Strategic Asset Allocation

 Source: Liontrust, June 2020

Changes have been fairly small, and the overall allocations to equities, bonds, cash and alternatives are broadly the same as in 2019.

Within equities, there have been a few changes, with the UK (and UK smaller companies) falling again, reflecting the region’s re-rating on a global level in light of Brexit and ongoing sterling weakness. In contrast, Europe and Japan exposure has increased slightly. Within bonds, developed market government exposure has fallen on the low-risk model, with a higher weighting to high yield and slightly more in emerging market debt in the medium-risk model. Finally, for the alternatives allocation, only represented in the medium-risk SAA, the property and hedge funds weightings have both fallen and commodities, included for the first time last year, has increased.

To reiterate, there is no tactical element to these changes but given the process is designed to produce the optimum basket of assets in terms of risk/reward to meet our volatility targets, the moves will often chime with our tactical thinking.

We are keen to move the TAA to a more aggressive footing post-Covid 19, while remaining within our risk parameters. We have been neutral since October 2018 when we pared back our US equity exposure, favouring areas where we see the best value – namely Europe, Japan, Asia and emerging markets.

At any point in time, our TAA ranges from one to five, with one being the most bearish on markets and five the most positive. We believe recent events give us scope to take advantage of cheaper equity valuations and increase risk to five. We would expect to continue favouring those same areas, which have been left behind by the surging US growth names in recent years.

We continue to follow our long-term SAA route but do expect a few tactical changes on the way over the next few months. What we will not do is turn our back on winning by not losing by chasing risk and we will only make those lane changes, as with any good driver, when it is safe to do so.

For a comprehensive list of common financial words and terms, see our glossary here.

 

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.

Thursday, June 18, 2020, 2:12 PM