EUROPE - A portfolio's returns are determined primarily by strategic asset allocation (SAA). On top of that, active managers may try to generate some extra returns by means of tactical asset allocation (TAA). A lot of careful consideration goes into determining the right SAA and TAA, so once they have figured out just exactly how much risk to take precisely where, it makes sense that institutional investors don't want to tinker with the allocation.
But that means investors may be missing out on opportunities, according to Russell Investments. Quite often one asset category will be just a tad more attractively priced than another. "To allow investors to profit from these opportunities, we have developed ‘enhanced asset allocation' or EAA," says Russell's Iheshan Faashee.
Ideally, investors would be able to plug into such opportunities and extract extra returns - but without having to mess up their strategic mix, and without getting in the way of their current active managers.
"EAA makes this possible," says Faashee. "Enhanced asset allocation barely affects the strategic investment mix, doesn't take up more than a fraction of the risk budget, and determines just 5-10% of the total portfolio return. The idea is to ‘fine tune' the allocation, earning just a few percentage points extra by making very modest adjustments."
EAA uses 10 different quantitative models to compare 114 pairs of asset classes and determine which of the two is the more attractively priced: growth or value, large or small caps, stocks or credits, and so on. These comparisons yield recommendations to fine tune the asset allocation.
"Take for instance a classical mix of 60% equity and 40% bonds," says Faashee. "If the EAA models come up with a positive outlook for equity, you might decide to not automatically rebalance but instead temporarily keep the mix to 63% and 37% bonds.
"This doesn't have a significant impact on the portfolio or the risk budget and it doesn't yield enormous returns - that is not what EAA is about. EAA is about yielding a bit of extra return without interfering with SAA and TAA," he continues. "SAA and TAA are the cake and cream, respectively. EAA is the cherry on top."