1. Presentation to Meet the Managers Roadshow:
Asset allocation in uncertain times
March 2019

2. Outline Is Asset Allocation the most important investment decision?
How should we form a long run asset allocation for our clients?
Application: building some HIP model portfolios

3. Why is asset allocation so important?
Risk and return are related - as allocations to growth assets are increased in a portfolio, long-term returns are almost always higher (Elroy, Dimson and Marsh 100-year dataset).
But asset allocation is also the most important determinant of returns for any given risk profile.
Research suggests that asset allocation is the most important contributor, (+90%) to the variability in returns (Brinson et al. 1986)
Variability in returns is not the same as long run returns or relative performance!
Typically 75% of performance attributed to asset allocation; 25% to security selection and tactical/dynamic asset allocation.
Can be as low as 40% for funds that have a very aggressive approach to dynamic asset allocation.

4. Why is asset allocation so important?
No matter how you cut it asset allocation is the most important investment decision.
Is this reflect in your firms’ philosophy?
How much time do you spend on risk and asset allocation compared to the managed funds beauty parade?

5. Why is asset allocation so important?
THE HIERARCHY OF DECISIONS
Most
Important
Time Horizon – Investment Strategy
Appropriate level of risk/return
Asset Classes Considered
Mix among Asset Classes
Sub – Asset Classes
Least
Important
Managers/Funds

6. How should we form a long run asset allocation?
Diversification is the one free lunch in finance (Harry Markowitz)
We should aim for long run asset allocations that:
are well-diversified
are robust to a range of future market environments
suit NZ-based investors
have clear performance benchmarks
are easy to communicate with clients, regulators, other parties
are easy to implement with a range of choices that respect business models and constraints (e.g. Advisers requirement for unitised products accessed via a WRAP)
can be consistently implemented (especially for DIMs holders)

7. How should we form a long run asset allocation?
We should be wary of long run asset allocation approaches that:
have no substance
are based on “proprietary” data and signals
“optimise” asset allocation weights (no substitute for judgement)
don’t consider longer term financial history
use unrealistic, extreme, or outdated capital market assumptions
are tuned to a particular economic environment (e.g. recessionary conditions)
result in high cash allocations
are difficult to implement and monitor on an ongoing basis

8. How we form a long run asset allocation
All models are wrong, but some are useful (George Box)
MyFiduciary’s approach:
Every client is different and so is their asset allocation.
But given our firm investment philosophy and understanding of Adviser businesses the we think a core-satellite approach is the best asset allocation model for Advisers.

9. How we form a long run asset allocation
CORE asset allocation
Core asset allocation comprised broadly diversified exposure to listed markets.
Core allocation is seen as the foundation for portfolio design and the success (or not) of a portfolio in meeting its purpose
Core includes:
Growth assets
Inflation resilient ‘real’ assets
Deflation resilient assets
Diversifying assets
Typically consumes a small fraction of the time of Advisers, unlike the glamour satellites…

11. How we form a long run asset allocation
Satellites may increase the portfolios risk- adjusted return via diversification and ‘alpha’ generated by manager skill and/or market inefficiency or temporal dislocation.
We don’t think it is prudent to assume satellites are necessary to meet portfolio objectives.
Satellites can help create a more robust portfolio and may be critical for an Adviser’s value proposition to clients.
Satellites may include: high conviction actively managed equity and bond funds; ‘smart beta’ funds that target risk factors (e.g. value); VC and private equity funds; absolute return funds; hedge funds; speciality sector funds (e.g. info tech); single country funds (e.g. India and China); etc, etc….
Long-term CORE asset allocation
Opportunistic: Thematic or market environment opportunities
Diversifiers:
Alternative sources of beta
Alpha sources:
Manager skill applied to market inefficiency

12. How we form a long run asset allocation
We form long run risk assumptions using CAPM because its relatively simple, replicable, and the key assumptions and judgments we apply are completely transparent in this framework.
We use long run spans of data as possible to inform risk (volatilities and downside events), asset class co-movements (correlations in ‘normal’ times, stressed times, and different economic environments) and returns (absolute return, real returns and risk premiums).
We also form medium-term risk assumptions using broad market DCF models that take into account current valuation levels and assume a mean-reversion process (NZSF approach).
Expected asset class and portfolio returns are function of the time horizon assumed. For this presentation 30-year horizon assumed.
This modelling helps inform satellite (and DAA) choices.

13. Our capital market and FX assumptions

14. Assumptions compared….

15. Some key AA issues in the current environment….
Rates are low and duration risk remains very elevated, deal by:
Tilting to lower duration bonds c/f Barclay’s Global Aggregate
Increasing exposure to IG credit vs. Sovereigns
Increasing exposure to fixed income fund with absolute return (cash plus) objectives.
US equities expensive, only value and EM equities appears materially ‘cheap’, deal by:
Ensuring EM equity exposures at least in line with global MSCI ACWI benchmark weights.
Selecting ex-US developed market funds and/or managers with more global view.
Selecting value focussed funds and/or managers
NZ interest rate carry very low (still positive on MSCI basis):
Hedging of offshore growth exposures less important (for now)

16. Lets build some HIP model portfolios
Lets build some HIP model portfolios. To start, some simple asset allocation rules go a long way…

17. From this we can develop a transparent set of benchmarks and asset allocations across risk profiles…

18. …that result in the familiar risk-return trade-off

20. As Chris will explain we then apply our fund selection framework… …and iterate many times…. …to populate the asset allocation with some HIP and not so HIP funds.

21. Some HIP Portfolios

22. Appendix

23. Appendix

24. Appendix

25. Appendix

26. MyFiduciary Adviser Support Services

27. Further Information Web https://www.myfiduciary.com
Phone
Advisory businesses and other firms that have achieved CEFEX accreditation
Accredited Investment Fiduciary (AIF ®) holders