Spreading the best wisely
Some people consider asset allocation - allocating a portfolio across various asset classes - to be relatively easy. You just have to own 70% equities in a bull market, and 30% in a bear market. But the reality is quite different – and much more complex.
For us, tactical asset allocation means: active control of the asset class mix over a medium-term decision-making horizon; value-added in addition to equity and bond management; flexible consideration of the investor's risk profile; an attractive risk-return ratio through broad strategy diversification; and implementation tailored to client's specific requirements.
Our rule of thumb is always that the greater the variety of available asset classes, the greater the additional
Our approach, called StratoMatrix, aims at creating added value for the investor in the long-term. It is based on a portfolio’s strategic asset allocation (benchmark) which is a function of the investor’s risk and return goals. We define the added value as an enhancement risk-return profile within the framework given by strategic asset allocation. The value-creation consists of three layers: market research and strategy development; risk budgeting and management; portfolio construction and implementation.
In a top down process, the key challenge is the reduced number of decision-making possibilities compared to stock or bond picking. Our investment philosophy takes this fact into account in two ways. In market research, we identify as many different performance drivers as possible and use them for developing strategy . We also combine several strategies in a portfolio through systematic, disciplined risk budgeting.
At StratoMatrix level I, market research and strategy development are carried out across asset classes (equities, bonds, money market) and within asset classes. We mainly pursue a fundamental approach with qualitative and quantitative decision-making. These independent decisions combined lead to an active portfolio.
Strategies are defined multi-dimensionally. In a one-dimensional approach for a regional portfolio, as in figure 1, region C may be overweight.
In our multi-dimensional system, we explicitly define an overweight status of region C versus region E: that is, active position 11. This increases the potential breadth in a strategy’s potential considerably.
At StratoMatrix level II, structured risk budgeting provides a diversification of risks as a function of estimated hit rates. These risk budgets are dependent on expected/attainable information ratio and tracking risk (wrongly referred to as the ‘tracking error’).
At StratoMatrix level III, portfolio construction and implementation is as follows: strategic asset allocation + model portfolios + total active risk budget = real portfolio.
Even if heterogeneous client targets and risk profiles lead to different portfolios, we aim at a high degree of consistency in the strategies across all funds. Our tactical asset allocation approach is based on the belief that success is dependent on strengths on all three levels in this value-creation chain.
The further evolution of our approach is driven by client requirements, research findings and a challenging capital market environment. Our aim of always improving our investment remains unchanged. Tactical asset allocation is an active management provided success service for multi-asset class portfolios. We implement it for pension fund mandates, funds of funds and also in segmented funds.
Our approach is based on the philosophy of making many uncorrelated multi-dimensional bets – or simply ‘do not put all your eggs in one basket’. Now for the visible outcome of our global asset allocation approach. We have recently slightly reduced our equity weight, but still remain overweight in this asset class. We are aware of current equity risk; however, this overweight status is a product of our valuation models and qualitative analysis.
Capital markets are currently subject to some uncertainty. Yet on the other hand, there are also positive economic facts such as stable, self-sustaining growth in the US, Japan and Europe, robust corporate profit growth, and limited interest rate increases due to low inflationary pressures.
Despite all this, the performance of stock markets in 2004 has been disappointing. We too are aware of the associated threats, since macro-economic momentum has probably peaked, corporate profits are losing momentum and the start of a new central bank rate cycle is a reality.
Risky asset classes have already reacted accordingly in the thin summer market, and this insecurity is being amplified by terror fears and high oil prices. We are aware of these risks and of investors’ declining appetite for risks. However, there is still value to be found in equities. For this reason, we remain overweight. We have also either retained or re-established an overweight in eastern Europe and global emerging markets.
We also maintain the off-benchmark position in Austrian equities we have held since 2002, though we have considerably reduced it. The Austrian market’s performance speaks for itself. In contrast, Japan, continental Europe and above all the Pacific region are underweight in our regional allocation. Other defensive elements of our asset allocation can be found in our sector weighting, where we prefer utilities, energy and healthcare over consumer discretionary and materials.
Our bond portfolio is also positioned defensively. Higher-weighted short-term bonds reflect a defensive positioning in relation to interest rate risks. We are also heavily underweight in foreign currencies.
In addition to European high yield bonds, emerging markets and eastern Europe remain attractive in our view, even where government bond yields are on the rise. This overweight is consistent with our equity weighting in these regions.
Klaus Glaser is chief investment officer at Raiffeisen Capital Management in Vienna