It is time to take a more active investment approach and be more flexible when constructing portfolios to ensure better returns, says international asset manager Schroders.
Its research has found that a balanced portfolio, traditionally investing 60% in equities and 40% in bonds, may not perform as well over the next 10 to 15 years as it did during the last decade.
“These static 60/40 portfolios have delivered a strong performance in recent years as both equities and bonds have benefitted from favourable policy tailwinds. It has been an unusual period in history as correlations between these key asset classes have been negative. Bonds benefitted from falling interest rates to generate strong returns while, at the same time, equities have enjoyed the longest bull run in history,” says Michael Devereux, multi-asset fund manager at Schroders.
However, he warns that there are serious challenges for such static portfolios going forward.
“Both equity and bond returns are likely to be lower in the future than during the past 10 years. Equities are facing economic headwinds and record valuations, while interest rates are at record lows and likely to remain low for years, affecting both the income and price appreciation potential for bonds.”
Schroders believes that investors should take a more active approach and consider a globally diversified portfolio of equities, fixed income and alternative assets.
Research by Schroders into the performance of asset classes during different economic cycles has shown that each asset class has times of good performance but might lag at intervals. Its analysts came to the conclusion that the same static 60/40 portfolio that performed very well in the past – delivering annual returns of more than 15% – is likely to disappoint and deliver less. In fact, the research found that the environment that delivered good returns over the last 10 years was unique when looking at the economic and investment history over the longer term.
The environment changed dramatically during the last few months, bringing a new economic and financial environment that will probably last for years to come.
Devereux says the solution to finding better and smoother returns is geographical diversification and flexible asset allocation.
“This approach focuses on actively managing a portfolio through these unprecedented Covid-19 times and into the future, with the ability to change how a fund is positioned depending on current and expected market conditions. Our actively managed multi-asset strategy is implemented through a combination of top-down asset allocation with bottom-up thematic strategies from leading fund managers in key asset classes,” says Devereux.
Schroders recently launched the Schroder International Selective Fund (Schroder ISF) Global Managed Growth in South Africa (SA) to offer this investment strategy to local investors.
“The fund has been designed specifically for South African clients who would like a growth strategy with a smoother path of returns than a static 60/40 balanced solution. The fund will be a combination of direct investments in equities, bonds and alternative assets, as well as investment in established funds,” says Devereux.
“As the SA regulator prohibits clients from buying funds that use derivatives for investment purposes, the fund will limit the use of derivative instruments to efficient portfolio management only.”
The fund is global, offering investors strong diversification benefits through access to a wide range of global assets, providing the SA investor with the opportunity to take advantage of local regulations permitting a greater proportion of funds to be invested outside of SA.
“At the heart of our multi-asset investment approach,” says Devereux, “is our analysis of each asset class and valuations throughout the economic cycle.
“We believe valuations of asset classes matter just as much as individual stocks and, since the path of returns matters, the macroeconomic environment needs to be taken into account.
“For this reason, we take an active approach and will tilt the portfolio based on high conviction asset allocation decisions. This means that the portfolio can be overweight or underweight toward specific geographical regions depending on the return opportunities and associated risks,” according to Devereux.
The fund will invest in a truly diversified set of assets – including equities, alternatives and credit – while using defensive assets such as government bonds to hedge the risks in the portfolio. Devereux says that this is especially important in today’s environment to protect the portfolio against geopolitical and economic concerns which can result in a volatile market.
“Every asset class has to earn its position in the portfolio by either enhancing returns or reducing risk.”
The Schroders investment team seeks to manage risk and enhance returns through asset allocation capabilities and dynamic management of asset class exposures, says Devereux. “With respect to our dynamic asset allocation specifically, we focus on identifying medium-term valuation opportunities and taking account of the economic environment.”
Schroders advises investors that Schroder ISF Global Managed Growth is designed to be flexible by nature. “We believe diversification remains paramount in managing overall risk. We have therefore set relatively wide ranges on the exposure to each asset class.
“The limits that have been set are deliberately wide to ensure flexible investment in asset classes that we believe will add significant value over the investment horizon. We believe these limits will ensure the portfolio is broadly diversified at all times and guarantee that no one asset class contributes excessively to total portfolio risk,” according to Devereux.
Schroders, founded in 1804 and managing multi-asset portfolios since 1947, has developed a proprietary risk management system, Schroders Multi-Asset Risk Technology (SMART), to understand and track the sources of risk within a portfolio.
“Should risk be concentrated in any one asset class, changes would be made to improve the diversification characteristics of the portfolio,” says Devereux
The fund managers conclude that the timely identification of potential changes in the macro-economic environment, as well as identifying potential risks and thematics that portfolios are exposed to, will enhance returns over the longer term and allow for outperformance while limiting volatility.
Brought to you by Schroders.