A dynamic approach to asset allocation
Category: Asia, Hong Kong, Global
Garth Taljard, head of multi-asset product, Asia at Schroder Investment Management (Hong Kong) Limited, gives Asia Asset Management insight into the firm’s approach to multi-asset investing.
Asia Asset Management: Under current market conditions, do you think a multi-asset strategy provides a stepping-stone for investors to move from fixed income to riskier asset classes?
Garth Taljard: Yes. Investors with low to moderate risk tolerance can no longer rely on traditional bond markets, given current low yields. A multi-asset approach allows them to capture growth from equities and alternatives without taking on excessive risk. We are also able to take advantage of diversification to achieve consistent target returns in different market conditions, supplemented by dedicated downside risk management to protect against market crashes.
How does your multi-asset approach fit in with clients’ risk tolerance and time-horizon requirements?
We have divided our business into five outcomes:
Wealth Preservation – looking for stable returns in all market conditions.
Risk Controlled Growth – targeting higher returns but with less volatility than pure equities.
Income for investors seeking sustainable income.
Inflation seeking to generate real returns and protect against inflation shocks.
Risk Mitigation – focusing on downside protection and volatility capping.
Each of these outcomes is designed to meet a typical investor’s needs, and serves as a starting point for designing portfolios. For example, an income portfolio will combine high dividend yielding equities with higher yielding bonds and alternatives such as property, to deliver a reliable stream of income. We then further refine the investment strategy depending on the specific risk tolerance, return requirement and time horizon of our clients.
Please describe the correlation between the asset classes in your portfolio? How does this help to diversify investment risk?
The different asset classes are affected by different factors. For example, equities and credit perform well during an economic recovery or expansion, whereas government bonds rally during a slowdown or recession. Alternative assets such as commodities or infrastructure provide protection against inflation. We look through the asset classes to identify their exposure to these factors, or “risk premia”. Risk premia are the compensation that investors receive for taking on growth risk, credit risk, inflation risk etc. By diversifying our portfolios across these different risk premia, we can provide our clients more stable returns in different market environments.
Will the effects of QE tapering cause you to restructure the com-position of your portfolio?
In 2013 the fear of QE tapering hurt both equities and bonds. Diversification did not work, and this meant the only safe haven was cash. So we raised cash in our client portfolios. Now, QE tapering appears largely priced in and long-term yields are less likely to spike upwards. We currently focus more on the imminent rise of short-term interest rates, with the US Federal Reserve likely to be first to act some time in 2015. Interestingly, our historic analysis shows that equities have performed well in previous interest rate tightening cycles, in the mid-1990’s and mid 2000’s.
Do you intend to cut back your weighting to fixed income in lieu of unfavourable bond market conditions?
We distinguish between government bonds and corporate bonds. Government bonds suffer during periods of economic recovery or higher inflation. We protect against this risk by reducing the duration of the bond portfolio: shorter-term bonds are less sensitive to rising yields. We do this either by switching out of longer-term bonds, or by selling US Treasury futures to reduce duration risk.
On the other hand, corporate bonds are often more sensitive to a financial crisis resulting in an increase in credit spreads. In this case we would reduce our exposure to poorer quality high yield bonds, instead focusing on high quality bonds issued by companies with strong balance sheets and good cash flow generation.
What is your investment approach to alternative assets?
We believe alternative assets are valuable only if they introduce proper diversification. Many hedge funds show a high correlation to equities, particularly in bear markets. We prefer to use alternatives such as commodities and infrastructure, which are driven by different risk factors to bonds and equities. Catastrophe bonds, where performance is related to weather events, are another example of a genuinely diversifying investment strategy. Since our clients require daily liquidity, we also avoid investing in less liquid instruments or those requiring a lock-up of client money.
Looking ahead, what do you see as the major challenges facing multi-asset managers?
Most asset classes globally look fair value to expensive, for example corporate bonds. It will be difficult to rely on market beta alone to deliver compelling returns. In addition, correlations between asset classes are unstable and have recently been more influenced by central bank policy than fundamentals. A traditional approach to “set and forget” static asset allocation is not the answer. We believe a dynamic approach to asset allocation, taking into account valuations, economic cycle and sentiment, will be crucial to navigate markets and achieve our investors’ outcomes.
For more information, please contact:
Schroder Investment Management (Hong Kong) Limited
Level 33, Two Pacific Place, 88 Queensway, Hong Kong
Telephone +852 2521 1633 Fax +852 2524 7225