Asset allocation – depending on who you believe – provides up to 90% of investment returns but there are other ways of approaching diversification.
David Jane, CF Miton Cautious and CF Miton Defensive Multi Asset manager
Our clients charge us with running multi-asset funds that are actively risk managed. In order to enable us to achieve the funds’ performance and risk objectives, it is crucial we have as much transparency and control of our risk exposures as possible.
When constructing our portfolios, we look at the world through macro and thematic lenses.
The macro identifies short-term economic ideas, while through thematics we identify long-term ideas such as new energy, onshoring and disruptive technologies.
We need precise exposures, and we need to ensure the macro and thematic are blended appropriately.
Breaking with tradition
To gain accurate exposure to these ideas, we generally construct a basket of stocks designed to amplify the common factor we want exposure to and dampen stock-specific risk.
This is not asset allocation as it is traditionally known, where decisions are usually taken at a sector level to gain cyclical and defensive exposure, or at a bond/equity level.
The more traditional asset allocation approach can sometimes be useful for our macro ideas but, even then, it is often too constrained and it is rarely helpful for our thematics.
The macro and thematic baskets are put together on the basis of how stocks behave, rather than which sector they are in, as two stocks in the same sector can be lowly correlated and two stocks in different sectors can be highly correlated.
Solid construction
Last year, we screened a large universe of European stocks, targeting companies with a material element of their earnings overseas.
Benefiting from the impact of quantitative easing on the euro, these companies were in a ‘sweet spot’ exhibiting strong growth and attractive value characteristics.
We carried out due diligence – around balance sheets, for example – which narrowed our selection down to about eight companies. We invested in this basket and applied a precise and flexible currency hedge in order to protect against excessive euro weakness.
We scaled the position sizes for risk, such as volatility, rather than conviction, reflecting our belief in emphasising robust portfolio construction and limiting the impact of human biases.
We would rarely want exposure to a whole market. Rather, we try to be specific and this can seldom be achieved through funds or indices, even at the specialist level.
For example, in the UK we currently want exposure to elements of consumer spending but not to banks or resources. Another example might be US high yield.
Recent opportunities have been thrown up in non-resources-based companies, as they are tarred with the same brush as the commodities companies that have suffered due to falling commodity prices, but we would not want exposure to the whole market.
Pure focus
The implication of all this is that we generally buy equities, bonds, property and commodities direct rather than through funds.
