NETHERLANDS - A simple countries model as part of a tactical asset allocation model can be extremely useful for explaining and predicting returns, says Dutch management consultant Compendeon.
It claims its models for equity markets – its year models for emerging markets in particular – are able to explain ‘quite a lot’ of price movement.
“The greater the explanatory power, the stronger the predictive capacity and the potential for alpha returns," write Harry Geels and Eric van Dijk, senior investment manager and chief investment officer/partner respectively.
They have based their conclusions on a study by G.P. Brinson et al., who showed the dominant role of asset allocation on the results of a total portfolio, and their own additional research. Brinson found that stockpicking contributed not more than 10% of the returns.
According to the Compendeon researchers, all methods of tactical asset allocation are better than a ‘free-floating’ portfolio. “The superiority of a strategy of regular rebalancing is particularly significant in the long term”, they stress.
Tactical investment, which is not based on a strategic asset allocation is not an option for pension funds because of their liabilities, say Geels and Van Dijk. “Depending on the liability structure, a strategic allocation which matches the future liabilities, should be developed. A tactical deviation is possible if it leads to better returns”.
Compendeon’s model for tactical asset allocation works top-down as well as bottom-up. For the most important asset categories – equity, bonds and real estate – it has developed models for 49 countries, both short and long term.
“If the number of countries which are more positive to equity increases, the equity asset category will press for a larger portfolio allocation,” say Geels and Van Dijk. “ This of course if the same doesn’t happen to other asset categories at the same time.”
Compendeon applies several variables in its models, including valuation and financial ratios, momentum and overreaction, and volatility, beta and duration.
According to the researchers, the model is especially effective for the emerging markets, but less useful for countries like Canada and Germany.