The global financial crisis (GFC) shifted the conversation from just chasing returns on investments to managing risk. Sticking to the right asset allocation mix meant the GFC had a short-term impact rather than a long-lasting effect for advisers like Calder.
But he said assets were stress tested vigorously post-GFC, and clients were focusing a lot more on risk management than ever before.
“I think there is an increased weighting to risk and probably in times when things were going so well pre the GFC, people got a little lax on that, looking for returns, but it is definitely on par now, because the risk of getting things wrong far outweigh the returns of getting things marginally right and then majorly wrong,” he said.
Prior to the GFC, portfolios benefited from selecting superior managers.
The housing boom may continue to go from strength to strength but the demographic boom, commodity boom, and the leverage boom have slowed down at a critical juncture, when more Australians are heading into retirement.
In this current environment, O’Dea said actively managing asset allocation played a much greater role in generating performance.
With Australian bond yields plunging from 6.5 per cent prior to the GFC to around 2.8 per cent at present, key defensive parts of a portfolio would now be trading at rather expensive levels.
Therefore, O’Dea opined that it was vital to be more active in asset allocations, and avoid expensive asset classes.
There had been unconventional monetary policies since the GFC such as quantitative easing and close to zero interest rates across many parts of the world.
“I think we have to be careful about managing too closely to peer groups in this environment because there is a level of complacency in the market and I think there is a heightened level of risk within market cap benchmarks,” O’Dea said.
He added managers should move away from peer groups and offer more flexibility in asset allocation.
Fund managers at multi-sector fund, Legg Mason, had moved away from traditional fixed income strategies to achieve returns for its multi-sector fund without increasing the risk profile.
According to chief investment officer, Reece Birtles, Legg Mason had increased exposure to a real income fund and an equity income fund, which provided significant levels of income without the level of risk associated with traditional equity exposures.
“We’ve managed to build strong returns into the portfolio without taking undue levels of risk despite the fact that cash and bonds are no longer offering adequate returns,” Birtles said.
He said the firm went underweight in global fixed income, and other risky asset classes like emerging markets, but went overweight in real and equity income.
He reasoned that while traditional equity portfolios had a volatility of around 15 per cent, real and equity income had a lower volatility of around 10 to 12 per cent per annum.
“These strategies still have a six per cent income yield but we haven’t caused the total portfolio’s volatility to go up given that we’ve built these positions that are in the middle of the risk-return curve, by going underweight both the high-risk high-return asset classes, underweight the low-risk, low-return asset classes,” Birtles said.
Let’s talk strategy
In terms of strategy, dynamic asset allocation might have been the exception in the industry, but O’Dea said it has become more commonplace today.
However, he said people are still largely tied to strategic asset allocation and building products according to various risk profiles and allowing the end client to choose which risk profile they would like to go into.
Where dynamic asset allocation was being used, O’Dea said it was being implemented by one source in many cases, where only one investment committee made decisions.
“We need to move to a much more diversified use of asset allocators so more people are contributing to that risk budget. We need to use more real return funds to be more active in asset allocation,” O’Dea said.
He said real return funds were more nimble and responsive to market opportunities than multi-managers.
Calder said dynamic asset allocation and active management should be a mainstay in a multi-manager fund to justify overlaying extra levels of management because strategic asset allocation was something planners could do themselves.
“I would think active management’s got to be a key component. Otherwise, what are you paying a multi-manager for?”
“They should be managing the active managers within that and seeking to manage the risks by the blending of the funds.”
He said dynamic asset allocation was suited to less sophisticated clients and investors, which would also be the segment for which he would use multi-managers.
Dynamic managers who blended different types of dynamics would be more effective in risk reduction and generating that extra alpha.
