Continuity in a Changing World: why we’re updating our Strategic Asset Allocation
For financial professionals only
In December 2020, Parmenion Investment Management (PIM) will implement a new Strategic Asset Allocation – the most significant change from the award-winning investment team in over a decade. Here, Parmenion’s Head of Intermediary Distribution Laura Barnes asks PIM’s MD Peter Dalgliesh to explain what’s changing – and why now?
My understanding of Strategic Asset Allocation is a portfolio strategy where the investment manager sets allocations for various asset classes and rebalances the portfolio periodically. Is that the PIM definition too?
Yes, although our definition would emphasise the long-term nature of the strategy. We understand asset classes behave differently in different market conditions, but over the long term we expect lower risk assets to provide defensiveness and higher risk assets to provide growth. We ride out short-term fluctuations, confident that a diversified portfolio will steadily compound over the years to deliver attractive risk adjusted returns.
This means we don’t alter our strategic weightings in an attempt to capture short-term movement or near-term opportunities. Instead, we assume that variations across asset classes will even out over time. We do make shorter-term tilts in our Tactical solutions, but even there, our long-term Strategic views are the neutral starting point when we look at markets.
If yours is a long-term view, why the change now?
Typically, our annual asset allocation reviews only show marginal variations in the risk and return characteristics of different asset classes from one year to the next, so over the past few years changes to our SAA have been minimal. Our 2020 review signalled an opportunity for refinements.
We’ve cross referenced asset class data with long term financial market trends that look set to continue, supported by qualitative information from our regular contact with major investment houses and expert fund managers.
The changes we’re making are designed to keep portfolios at every Risk Grade diversified across asset classes, and within suitable boundaries of volatility.
The affected solutions are Strategic Multi Option, Strategic Passive, Strategic Conviction, Tactical Active and Tactical Passive.
How much has the pandemic influenced these changes?
2020 has been a strange and challenging year, but changes to our Strategic positioning are driven by risk awareness and robust data.
We avoid behavioural biases like reacting to what may feel like significant events today, but don’t actually represent a long-term structural shift.
Instead, we look to take account of long-term structural changes, such as persistent subdued economic growth, inflation and compressed yields. This is a world encumbered by ballooning debt and ageing demographics, revolutionised by technology, and with a growing awareness of the role of ethical, sustainable and ESG in investing.
Many of these trends have been on the horizon for some time, and perhaps some have been accelerated by the current global health crisis. But we aren’t reacting to that – we are adjusting our asset allocation to acknowledge long-term structural changes evident in the data.
What do these changes mean for PIM’s ‘risk first’ investment philosophy?
Our risk-centric approach is unchanged since Parmenion’s inception and will continue to be at the heart of everything we do.
Our Risk Framework is built from 20 years of index data, giving us a solid understanding of the historic behaviour of each asset class we invest in, their correlation with each other and their risks expressed as both volatility and maximum loss.
It also indicates whether our long-term assumptions about different asset classes continue to hold true, or if, as we’re doing now, changes need to be made.
So what’s the most important change?
Let’s start with bonds. The ‘lower for longer’ environment around inflation and yields has led to variations in correlation and volatility within Fixed Interest.
Our new SAA will separate out the constituent parts of this asset class into UK Gilts, UK Index Linked Gilts, UK Corporate Bonds, and Global Strategic Bonds.
This gives us the flexibility to adjust across these defensive asset classes to deliver favourable risk adjusted returns, especially for lower Risk Grade portfolios.
And what about global opportunities?
The rise of disruptive technology in our everyday lives, shifts in global demographics, and increased consumerism in previously less developed regions, have meant the differences in risk adjusted returns for Emerging Markets and Asia Pacific ex Japan equities have narrowed versus their developed market peers. This can be seen across correlations, volatilities and max drawdown.
This, combined with the supportive long term growth prospects they offer, has led us to modestly increase our weightings to both Asia Pacific ex Japan and Emerging Markets where appropriate. Of course, this only affects the mid to upper Risk Grades.
Is the UK in or out of favour in your new thinking?
Our ongoing analysis examines the long-term risk-return characteristics of UK equities to make sure they fit with our strategic approach.
As we’ve seen UK volatility and max drawdown converge towards that of non-UK equities, a reduction in UK exposure across Risk Grades is appropriate.
However, while this reduces the domestic UK bias of our portfolios, it does not remove it. Although the UK is an unloved market at the moment, our 20-year data set demonstrates solid long-term risk-return characteristics of UK equities. This is what determines our continued allocation to them within a diversified multi-asset portfolio.
Additionally, our core investor base is UK resident, so this home bias offers exposure to international earnings through UK listed companies, while mitigating additional currency risk.
Commercial property is an asset class that’s had a lot of negative press over the past year. What are your plans there?
Our analysis has confirmed the unique risk adjusted return attributes that commercial property brings to a diversified multi-asset portfolio through our 20-year data set.
As a result, property keeps its place as a core element in our solutions. As we move through the middle and upper Risk Grades, we’ve tweaked our exposure, tapering at the higher risk grades where its defensive qualities are less critical to long term outcomes.
Are we likely to see more frequent change in Parmenion’s SAA in the future?
Given the pace of global change and evolution of capital markets, our annual SAA review requires increasing levels of research and analysis. We may look to make subtle changes on an annual basis to capture the output of that review.
Importantly though, this won’t change our Strategic focus, nor the discipline of our process, and doesn’t mean we’ll be bringing tactical positioning into our Strategic Asset Allocation.
We remain very clear on the distinction between our long-term strategic approach and short-term tactical positioning. In fact, we pride ourselves on delivering that additional value explicitly within our Tactical solutions.
How confident are you in the changes you’re making?
This is a superb example of our investment team’s dynamic approach to a rapidly evolving world and our expertise in marrying it with our hallmark focus on risk, and rigorous process. Our asset allocation is the strong foundation on which our portfolios are built, with each risk grade following our risk framework and the acceptable volatility boundaries it creates.
We remain focused on the delivery of superior risk adjusted returns in line with client expectations, achieved through carefully constructed portfolios. That means our customers can remain focused on their clients, and feel confident in the suitability of the investment outcomes they have entrusted to us.
Laura Barnes, Head of Intermediary Distribution
Peter Dalgliesh, PIM Managing Director
“The above article is intended to be a topical commentary and should not be construed as financial advice from either the author or Parmenion Capital Partners LLP. If a client wishes to obtain financial advice as to whether an investment is suitable for their needs, they should consult an authorised Financial Adviser. Past performance is not an indicator of future returns.”
Any news and/or views expressed within this document are intended as general information only and should not be viewed as a form of personal recommendation. All investment carries risk and it is important you understand this. If you are in any doubt about whether an investment is suitable for you, please contact your financial adviser.