Analysis and insight into some of the strategic processes involved in deciding asset allocation strategies, by Tara Jameson, Co-Manager of the Schroder Global Multi-Asset Portfolios.
The long-term risk and return characteristics of asset classes, while not set in stone, change very little over time. This is extremely helpful when you’re designing an investment strategy to meet a client’s long-term investment goals. It means you can reliably construct a portfolio framework that matches the risk and return characteristics that your client is looking for.
Yet investment markets move constantly due to external events, cyclical changes in the economic environment and shifting investor sentiment. This means there will inevitably be times when individual asset classes deliver returns towards the negative extreme of what can normally be expected. There will also be some moments when the way that asset classes behave in relation to one another doesn’t conform to what would be expected in normal conditions. We saw this in 2022 when the US Federal Reserve started raising interest rates to fight inflation and the prices of stocks and bonds fell simultaneously.
This has significant implications for the experience a client can have with their portfolio. If the asset allocation of the portfolio remains static for example, there can occasionally be times when short-term returns can be significantly worse than they may be used to experiencing. Which, for some, may prompt second thoughts about sticking with the investment strategy that they signed up for.
Helping your clients stay invested and reach their investment goals
How can you ensure the risk and return balance of a client’s portfolio remains right for them, while providing a smoother investment journey and the prospect of a better outcome? The answer is to combine a dynamic approach to asset allocation, that addresses cyclical and event driven changes in market risks and opportunities, with a solid underlying strategic asset allocation framework. This is the approach that the Schroder Global Multi-Asset Portfolios take.
Our investment philosophy focusses on how the market values different assets compared to where we would expect them to be given our outlook on the stage of the economic cycle. For example, in the expansion stage of the economic cycle, equities tend to outperform bonds while in the slowdown phase bonds tend to outperform equities.
To deliver the best outcomes for your clients, it’s vitally important to get both the strategic and the dynamic elements of the asset allocation equation right. To help us with this, we have a team of over 140 Multi-Asset specialists based in the UK, US, Europe and Asia Pacific region, looking at markets from every angle.
Step 1 – Strategic asset allocation (SAA)
The SAA of a portfolio is the main factor that will drive returns over the medium to longer term and should closely reflect both what a client is hoping to achieve and their attitude to risk. To get this first step in portfolio construction right, we use the long-term capital market assumptions from our in-house economics group, which include assumptions on the level of risk of each asset class and the relationships between them. It also includes a long-term expected return based on factors that drive economic growth such as increasing population size and improving productivity. From this, we build a series of graded strategic allocations to reflect the needs of different clients from the most adventurous to the most cautious.
As the long-term return potential, risk profile and relationships between asset classes can change gradually over time, we formally review the strategic allocation framework for portfolios on an annual basis.
SAA evolution in practice
During our SAA review in 2022, we removed a strategic allocation to UK gilts within our portfolios and increased the allocation to global government bonds. As we have gradually reduced the allocation to UK equities within our portfolio SAAs it made less sense to hold UK bonds specifically as a hedge for that exposure. Diversifying exposure across a global opportunity set should help to reduce the overall risk of portfolios by providing better protection against unexpected events that may negatively affect a specific country or region.
Step 2 – Dynamic asset allocation (DAA)
To get the DAA of our portfolios right, we use a disciplined “risk premium” investment approach, which decomposes asset classes into their underlying drivers of risk. We do this because simply allocating across multiple asset classes won’t always achieve true diversification. There can be times when two assets classes that are normally diversifying are exposed to the same underlying risk. For example, in 2022 the key risk to equities was rising bond yields because of the impact that had on valuations. Therefore, equities were exposed to exactly the same risk as bonds (i.e. rising yields).
Our risk premium approach helps us to understand the true drivers of risk and return and how they interact. It also enables us to form a positive, negative, or neutral view of the relative attractiveness of asset classes at any point in time, which we derive primarily from in-depth analysis of valuations, cyclical factors and technical factors. Alongside this, we combine quantitative tools with forward-looking scenario analysis to manage risk. We also use in-house sustainability tools to ensure ESG factors are woven into every aspect of our Multi-Asset research and portfolio construction.
Our specialist teams meet formally once a month to discuss their asset class views and to determine any changes that would benefit portfolios. As market conditions can move significantly over the space of a few days, we will also make changes at any time when warranted by major events, while always looking to ensure that portfolios are not exposed to any unwarranted risks.
DAA in practice
One example of DAA that we have used in the Global Multi-Asset Portfolios range this year is to add an overweight position in gold, which has been held in the portfolios since mid-January. Following a period of significantly rising interest rates around the world, we have now seen clear evidence of a pivot in monetary policy by major central banks such as the US Federal Reserve. Our dynamic asset allocation research process indicated several scenarios which, we believe, makes gold an attractive asset to currently own, from both a return-seeking and a risk-reducing perspective:
- Interest rate cuts: Traditionally, gold tends to perform well in an environment of falling interest rates. This is in part because lower rates reduce the opportunity cost of holding gold, which doesn’t provide a yield to investors.
- Weaker US dollar: The prospect of falling US interest rates can potentially weaken the dollar relative to other currencies as it becomes comparably less attractive. As gold is typically priced in US dollars, this can make gold cheaper for investors holding other currencies, potentially boosting demand.
- Chinese domestic and central bank demand: Central banks, especially in emerging markets, have long been significant buyers of gold but we are also seeing high levels of domestic demand for gold relative to history. Over the past few years Chinese savers have been increasingly choosing gold as their preferred store of wealth – gold now surpasses other more traditional options such as bank savings, stocks and bonds.
- Inflation and geopolitical hedge: Gold is seen as a ‘safe haven’ asset. It has a limited supply which supports its value during times of geopolitical unrest. Gold is also a ‘real’ asset, meaning it has intrinsic value due to its substance and properties. Real assets are often seen as protection against inflation because their value doesn’t depend on a promise to pay a yield or dividend, unlike financial assets like bonds or stocks.
Delivering better outcomes for you and your clients
Chart 1 shows the evolution of the asset allocation of the Schroder Global Multi-Asset Balanced Portfolio, one of our five risk-mapped Multi-Asset funds. The funds dynamically adjust exposures across a range of asset classes in order to adapt to ever-changing market conditions. The funds offer you and your clients the best of Schroders’ global expertise, combined with both active dynamic and strategic asset allocation and active stock selection, with an Ongoing Charge Figure (OCF) of just 0.22%.
Chart 1: active management in action in the Schroder Global Multi-Asset Balanced Portfolio
Source: Schroders, as at 31 March 2024. Alternatives consists of investments which are not a component of the strategic asset allocation. This can consist of, but is not limited to, investments in commodities, emerging market debt, high yield & REITS.
Alternatively, contact your usual Schroders’ representative or call our Business Development Desk on 0207 658 3894.
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About Tara Jameson, CFA
Tara joined Schroders in 2014 and is a Multi-Asset Fund Manager. She manages assets on behalf of UK pension & wealth management clients and is co-manager for the Schroder Global Multi-Asset Portfolios. Tara is also Head of the Credit Research Group within Multi-Asset Investments at Schroders. She was previously a Solutions Manager within the Risk Managed Investments team until 2018, which involved designing and constructing systematic risk management and option strategies. Tara is a CFA Charterholder and holds a degree in Natural Sciences from Cambridge University.
