Partner Insight: Combining strategic and dynamic asset allocation to deliver better outcomes for your clients

clock • 8 min read
Partner Insight: Combining strategic and dynamic asset allocation to deliver better outcomes for your clients

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 be 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 130 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 used in the Global Multi-Asset Portfolios range was to add an overweight position in broad commodities (which can include oil, metals, and agricultural products) in 2022. While some DAA decisions can be shorter term, we held this  position for the majority of the year. In a year characterised by slowing global growth and rising inflation, most major asset classes such as equities and bonds fell in value; however commodities recorded positive returns. This was in part because rising commodity prices were one of the primary causes of inflation, but other global factors also had an impact. Russia's invasion of Ukraine and China's zero-Covid policy together created supply bottlenecks in the global supply chain which pushed up the price of underlying commodities. 

Delivering better outcomes for you and your clients

The chart below 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%.

Active management in action in the Schroder Global Multi-Asset Balanced Portfolio

Source: Schroders, as at 28 July 2023. 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.

Find out more

For more information about the Schroder Global Multi-Asset Portfolios visit schroders.com/globalmultiasset. Alternatively, contact your usual Schroders' representative or call our Business Development Desk on 0207 658 3894.

 

 Important information

Marketing material for professional clients only. This document does not constitute an offer to anyone, or a solicitation by anyone, to subscribe for shares of Schroder Investment Solutions Fund Company (the "Company"). Nothing in this document should be construed as advice and is therefore not a recommendation to buy or sell shares. Subscriptions for shares of the Company can only be made on the basis of its latest Key Investor Information Document and prospectus, together with the latest audited annual report (and subsequent unaudited semi-annual report, if published), copies of which can be obtained, free of charge, from Schroder Unit Trusts Limited. Any reference to sectors/countries/stocks/securities are for illustrative purposes only and not a recommendation to buy or sell any financial instrument/securities or adopt any investment strategy. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Reliance should not be placed on any views or information in the material when taking individual investment and/or strategic decisions. Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested. Exchange rate changes may cause the value of investments to fall as well as rise. Schroders has expressed its own views and opinions in this document and these may change. Information herein is believed to be reliable but Schroders does not warrant its completeness or accuracy. Schroders will be a data controller in respect of your personal data. For information on how Schroders might process your personal data, please view our Privacy Policy available at www.schroders.com/en/privacy-policy/ or on request should you not have access to this webpage. For your security, communications may be recorded or monitored. Schroder Investment Solutions is the trading name the Schroder Global Multi-Asset Portfolios. The Schroder Global Multi-Asset Portfolios are provided by Schroder Unit Trusts Limited, 1 London Wall Place, London EC2Y 5AU. Registration No 4191730 England. Authorised and regulated by the Financial Conduct Authority.

 

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