In these times of heightened macroeconomic and geopolitical volatility, do big asset allocation calls help navigate the investment environment? We asked three different types of funds for their views on the matter.
When [i3] Insights started in 2016, one of our early interviews was with Professor Alan Dupont, a geopolitical strategist, who predicted that the world was entering a period of systemic economic and political volatility due to a shifting global power base, eroding the hegemony of the United States, and an increasing interconnectedness on the back of technological development.
Dupont could not have known that merely five years later the world would indeed be a much more volatile place as a global pandemic engulfed the world, China flexed its muscles and Russia was threatening to invade Ukraine.
But what do investors make of this turmoil? Does this provide them with the opportunity to take big asset allocation decisions, or have regulations and the commoditisation of big data spoiled their chances of taking meaningful macro bets?
At Cbus, the pandemic has reinforced the importance of integrating secular trends into the broader investment process and understanding sources of risk at the portfolio level, Leanne Taylor, Head of Asset Allocation and Portfolio Construction at the fund, said.
“What COVID has done for us is that it really has brought our team together and really integrated that top down and bottom up,” Taylor said during a panel discussion at the [i3] Asset Allocation Forum in Bowral earlier this month.
“It is really about understanding where your risks are and ensuring resilience in your portfolio as best as possible. You don’t want all of your portfolio exposed to a single source of risk or market vulnerability,” she said.
The Your Future, Your Super regulations have made it more difficult to express some investment ideas in the portfolio as any significant tracking error from the benchmarks the prudential regulator APRA uses in its performance test are highlighted.
But Taylor argued that this doesn’t mean you can’t make any changes to your strategic asset allocation (SAA).
Your Future, Your Super (YFYS) is another consideration in the SAA process... With some of the YFYS reference portfolio benchmarks not necessarily reflecting some of our underlying portfolios, we need to understand where we have conviction to take tracking error risk – Leanne Taylor, Cbus
“Your Future, Your Super (YFYS) is another consideration in the SAA process. The SAA will continue to play an important role given we are benchmarked against it, as well as to aid member communication.
“With some of the YFYS reference portfolio benchmarks not necessarily reflecting some of our underlying portfolios, we need to understand where we have conviction to take tracking error risk,” she said.
“Yes, we have to have an SAA, but particularly when there is more uncertainty than is the norm, we have to test the robustness of our centrist portfolio against alternative scenarios.”
“Whilst we manage to an SAA we also integrate whole-of-portfolio thinking to ensure the portfolio is robust both across and within asset classes. This also ensures we can assess where we can get the best bang for our buck on a risk-adjusted basis,” she said.
Cbus also has a dynamic asset allocation program that has the objective to add alpha. But Taylor said the levers the fund can use under this program are constrained to the listed markets.
“We have a significant allocation to private markets, which broadens the opportunity set for our diversified options, but due to liquidity and capital deployment considerations they are not part of our DAA”.
“Our opportunity set is the listed markets and our time horizon is, on average, nine to 12 months. It is not so much an explicit risk management tool for us, but we are obviously mindful of total portfolio exposures in sizing our DAA positions. It is an explicit alpha source, but we also need to manage it in the context of our broader portfolio,” she said.
The Future Fund is not constrained by the superannuation environment and operates a total portfolio approach rather than a set strategic asset allocation.
“We don’t operate with an SAA,” Richard Cooney, Strategist, Dynamic Asset Allocation at the Future Fund, said. “We are very much looking for a portfolio of things that resonate and that is really a comparison of portfolio opportunities on a like-for-like basis.
“So we are comparing all the opportunities and assessing their role in the portfolio, rather than investing with a defined target or benchmark. In that context, we see a role for both private and public assets in our portfolio.
“Another part of our process is that we need to manage and preserve our liquidity and flexibility, so that if there is a shock, we are well-positioned to counter-cyclically adjust our portfolio,” he said.
We are relatively humble about our previous history and experience in DAA. We’ve made some high margin, impactful calls, but those are quite chunky – Richard Cooney, Future Fund
Like Taylor, Cooney was careful to note that the returns from its DAA calls will not present themselves as a nice, steady income stream.
“We are relatively humble about our previous history and experience in DAA. We’ve made some high margin, impactful calls, but those are quite chunky,” he said.
Insurance company Suncorp is faced with a different set of constraints. Rather than a relatively strict SAA, as is the case with Cbus, or a broad mandate that relies on partners as is the case with the Future Fund, Suncorp needs to invest in line with its insurance liabilities. This makes the company a rather conservative investor, a mindset that is reflected in its approach to asset allocation.
“We analyse our business lines to determine: ‘What is our claims exposure? Is it long tail or short tail? What are the underlying characteristics?’ And then we try to find assets that match those exposures,” Jill Monaghan, Chief Investment Officer of Suncorp, said at the forum.
“We are not trying to predict the future, but we are aiming to ensure we are in the best position across a range of outcomes. This will naturally lead us to a more conservative and defensive bias,” she said.
Suncorp also makes use of dynamic asset allocation, but not in the same way as Cbus or the Future Fund.
“The main purpose of DAA is really for downside protection,” Monaghan said. “And while the investment strategy defines our SAA, DAA is more heavily influenced with considerations from our economic and markets outlook, which actually works really nicely.”
Inflation
Although the pandemic and Russia might steal the headlines now, for investors the longer term problem is inflation.
While initially the increase in inflation was considered transitory, induced by supply chain problems stemming from the coronavirus pandemic, today more and more investors are concerned that the world is faced with a structural move towards higher inflation.
This change is partly inspired by comments from Federal Reserve Chairman Jerome Powell and Treasury Secretary Janet Yellen in December last year, when they argued it was time to retire the term ‘transitory’ when discussing US inflation trends.
The main purpose of DAA is really for downside protection,” Monaghan said. “And while the investment strategy defines our SAA, DAA is more heavily influenced with considerations from our economic and markets outlook – Jill Monaghan, Suncorp
The Future Fund recently concluded a broad review of its investment strategy and in its new view of the investment environment inflation featured a prominent role in this.
“What we saw was a regime of increasing inflation risk, skewed to the upside,” Cooney said. “We need to understand what that looks like, what it means for duration in the portfolio and defensiveness more broadly. Where can we find defensiveness in a world where the role of traditional duration is challenged?”
The Future Fund sees opportunities on the private side that could fill the role of inflation hedging. Equally, on the public market side, in the equity portfolio, the fund deploys investment styles, including value and quality, that should mitigate an inflationary environment.
“Hopefully, the value side will hold up in a higher yield environment and probably the quality side allows us to have inflation pass-through in terms of cash flows,” he said.
Inflation has a deep impact on insurers, as they rely heavily on fixed income investments to cover their liabilities. But Monaghan said there are nuances as to how it affects each business line.
“Inflation is a big issue for us, but not in the same way across the different lines of insurance business. Some of them will be CPI linked, while others will have other types of inflation,” she said.
Inflation linked bonds provide some solace, but it is not a panacea.
“We use inflation linked bonds; that has been a big part of our portfolio. But there are good and bad times with them. They are incredibly volatile, which goes back to my corporate consideration: volatility is a big deal,” she said.
“We are trying to say: ‘We know the profile that we are trying to hedge. What are the right assets?’ Clearly, we want to be able to meet the obligations of our liabilities, so we are inevitably defensive with a fairly liquid portfolio,” she said.
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[i3] Insights is the official educational bulletin of the Investment Innovation Institute [i3]. It covers major trends and innovations in institutional investing, providing independent and thought-provoking content about pension funds, insurance companies and sovereign wealth funds across the globe.