We have just concluded our annual review of our funds’ strategic asset allocations. We have made some small changes to the underlying assumptions but not to the weights themselves.
"US companies are probably more dynamic than in other parts of the developed world"
To recap, our strategic asset allocation for a particular fund is constructed so as to achieve a particular real return – once fund costs and expected value added are accounted for - over the long term, as well as good diversification. Ultimately, we believe that by achieving a certain real return, the fund in question will attain top quartile status over the medium to long term in relation to its respective peer group. The inputs to the calculation for a particular fund are thus: (a) the long-term expected real returns we expect each of the asset classes in which our funds invest to achieve; (b) the real return objective of the fund; (c) the value added we expect to generate from active management and (d) fund costs. While we are aware of the volatilities of and correlations between asset classes, we do not use complex optimisation models. We do however model the SAAs to check that they have achieved in the past what we want them to achieve in the future.
Changes to the long-term return assumptions can be seen in the table below:
The changes relate only to equities and within equities to all regions/countries other than North America (for which read ‘US’).
The rationale for the changes is simple: we think that economic growth is likely to be lower over the long term across the globe. At the same time, we acknowledge that US companies are probably more dynamic than in other parts of the developed world, and also that a negative adjustment should be made for the poorer governance of companies in emerging markets. In sum, this means a 1 percentage point reduction everywhere other than in North America.
We have not made any changes to expected returns within fixed income or specialist assets.
As for assumptions about the value added we can generate through active management, we have increased our targets for UK equities and overseas equities from 2% to 3% and from 1% to 1.5% respectively. This is an acknowledgement of our mid cap focus in the UK (mid cap stocks over time have beaten large caps by a significant margin, something we expect to continue). As for overÂseas equities, we are making more use of our capacity to be more concentrated as well as our capacity to invest in smaller, more dynamic funds. Both of these we feel increase our scope to add value.
Published in Investment Letter, June 2016
The views expressed in this communication are those of Peter Elston at the time of writing and are subject to change without notice. They do not constitute investment advice and whilst all reasonable efforts have been used to ensure the accuracy of the information contained in this communication, the reliability, completeness or accuracy of the content cannot be guaranteed. This communication provides information for professional use only and should not be relied upon by retail investors as the sole basis for investment.