Strategic asset allocations provide robust risk and return framework but are based on long-term asset class views, as described by capital market assumptions.
Markets have been incredibly volatile, and they remain elevated, which can present challenges in the creation of strategic asset allocation models. Essentially, strategic asset allocation models fall into one of two broad categories with quite distinct, characteristics:
- The first tends to be static and will only change at a fixed point in time and are therefore not market sensitive. They, therefore, fit well with a tactical asset allocation process as this operates independently from the strategic asset allocation. This is the kind of model which Square Mile adopts.
- Other models are reviewed with greater frequency and blend tactical and strategic views in their construction process. These can be referred to as dynamic asset allocations.
Both approaches need to consider portfolio positionings during times of market volatility, however dynamic asset allocations are more likely to make changes- which can run counter to any tactical positions taken. For example, if the dynamic asset allocation approach adds to the UK equity exposure, the relative allocation in the portfolio will become different from the initially desired position. While this challenge is not insurmountable, it can create additional trading, particularly when markets are elevated or are experiencing increased volatility.
Strategic asset allocations provide robust risk and return framework but are based on long-term asset class views, as described by capital market assumptions. However, in the short term, they can oversimplify the world as the indices that are used to describe those asset classes can change over time. We feel it is important to highlight a couple of good examples that the recent crisis and resultant volatility has caused that we have to consider when putting portfolios together to counter these risks:
- The S&P 500 is the most frequently used index to describe the US market. Today, only five stocks account for 25% of that index: a significant change from their historic weightings. The concentration risk has increased.
- Within the gilt market, the government has been issuing bonds with a much longer duration than they have done historically. In doing so, the government has taken advantage of lower interest rates to lock-in lower payments for longer. However, this has had the effect of increasing the interest rate sensitivity of the index.
Finally, turning to property, the complexity of measuring this asset class makes it problematic. A good strategic asset allocation model should be easily measurable and investable. However, it is not possible to invest in the Investment Property Databank index, the index describing property, nor is it easy to measure at present given the funds are closed due to the implications of Covid 19. This presents a technical, quantitative reason for why it is not attractive. In addition, however, the long term risk-return outlook for property is not favourable in our view, and so if there is to be no exposure to property within the model portfolios, it makes sense to eliminate it within the strategic asset allocation and therefore measure returns against it.
Chris Fleming, Investment Services Director
Park Hall Financial Services Limited is authorised and regulated by the Financial Conduct Authority.
The information within this article is for information purposes only and does not constitute investment advice. they represent the opinions of the fund manager and those of Square Mile. It does not contain all of the information which as an investor may require in order to make an investment decision. Any reference to shares/investments is not a recommendation to buy or sell. If you are unsure, you should seek professional independent financial advice
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