Sam Houlie – Portfolio manager of the Counterpoint SCI Cautious fund
Over the last few years, has it been more important to get the asset allocation right, or to be in the right stocks?
In broad terms, I have observed the following over the past 18 years. Between 2003 and 2005 the virtuous combination of very high embedded real yields in the fixed income space and very depressed equity markets suited a ‘formulaic’ and ‘strategic asset allocation’ approach. The since-inception track records of low equity funds launched before the great financial crisis in 2008, will generally show real returns in excess of 4% and even as high 6%. The initial yields and valuation tailwinds ensured these high real returns.
Asset allocation mattered most (and added the most value) in these early years. Since 2009, however, both asset allocation and security selection have been equally important. Notably, security non-selection (stocks or sectors which you can intentionally avoid) has mattered more in equity markets that have become distorted by central bank intervention.
I have always believed that the low risk-budget (40% maximum equity exposure) allowed in low equity funds offers the greatest opportunity for aggressive and high-conviction positioning. In addition, the range of risk-opportunities has expanded significantly over the last 18 years. The offshore potential has increased from 10% to 30%; direct commodity exposure has expanded in breadth, and trading liquidity has increased; and the use of hedged equity strategies is now more common.
The secular decline in interest rates has also reduced the real-return prospects of the strategy on a formulaic basis. A 1% to 2% real return is now attainable at much higher volatility. That is a far cry from the embedded returns available 18 years ago.
How do you think that will change over the next few years in the wake of the Covid-19 crisis?
The heightened uncertainty from Covid-19, will suit a portfolio management style that is more nimble, with the ability to change your mind as new information becomes available. The speed of the recent decline, response and recovery is an indication of how quickly markets move nowadays.
We believe that asset allocation and stock selection are equally important, in managing a low equity balanced fund. The aftermath of Covid-19 and lower interest rates will increase the importance of using the full equity risk budget in the most optimal way.
The best way to do this is to be nimble and ready to exercise judgement aggressively when the risk-reward profile is favourable. The risks you choose to accept and the ones you choose to avoid, will become more important. For example, if bonds become a lower yielding, higher volatility asset class – why not hold cash and allocate to bonds at extremes (as was the case in February to April of this year)? Prioritising exposures will become even more important.