The beginning of 2022 has been a torrid time for investors and advisers, with dual corrections occurring in both traditional long-duration fixed income assets and growth-oriented equities that have driven portfolio returns for the last decade. The result has been a marked and growing dispersion between model portfolios across firms and clients.
Falling interest rates have offered a strong tailwind for almost all risk assets for several decades, which in my experience resulted in advisers and asset allocators spending more time focused on active management and individual investment selection as the key source of alpha.
History, and 2022 in particular, has once again shown the importance of focusing first on the ‘boring’ part of investing, being strategic asset allocation. Various academic studies have concluded that anywhere from 80 to 90 per cent of returns ultimately come from asset allocation decisions, but unfortunately little time is spent there.
From a career advising pension and sovereign wealth funds, the one differentiating point that I consistently notice, is that they have the luxury of being able to take a longer-term view when it comes to portfolio construction. That is opposed to the financial advice and wealth management sector, being directly client facing, tend to have a shorter investment time horizon and therefore are more reactive to short-term movements.
Much can be learned and extracted from the approach taken by pension funds, who continue to invest heavily in understanding and modelling how their portfolios will react in varying circumstances and conditions. This is something also underlined by the regulator, APRA’s governance standards for the same super funds.
The more reactive nature of advised clients quite often leads to unintended deviations from strategic asset allocation, in many cases as a result of making changes to portfolios based on short-term performance results, and potentially impacting on style, factor and other biases in the process.
These should be central considerations in any strategic asset allocation framework, which brings discipline to the investment process. For many, reviewing SAA remains a “tick the box” exercise, with a focus on alpha through asset selection, not through tactical or strategic weightings. The only way to reverse this is through a detailed, institutional-style framework and the imbedding of SAA discussions within investment committee meetings.
One problem regularly highlighted by advisers, is the accessibility of quality data and support to assist in building and modelling the implications of changes to SAA and TAA decisions. In many cases, these are cost prohibitive and reserved only for large institutions and asset consultants, yet their potential value is significant. This is a key reason behind the growing demand for asset consultants and the continued professionalization of the advice industry.
Jake Jodlowski, principal, Atchison Consultants
Neil is the Deputy Editor of the wealth titles, including ifa and InvestorDaily.
Neil is also the host of the ifa show podcast.
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