Christopher Aldous, head of asset management at Charles Stanley, details the absolute return funds they are backing.
'It is easy to understand why asset allocation was a poor cousin in the days when most fund managers followed index-based benchmarks and tried to make the difference via the stocks they picked. Even today, star fund managers tend to be stock-pickers. The traditional active model, does not require asset allocation by a star and it is often set by a committee or bought in from an external provider. This is evidenced by how many model portfolios providers just follow the asset allocations set by one of the risk profilers.
Despite this, the idea that asset allocation is more important to long term performance than any other factor has gained many followers. Every portfolio has its asset allocation – you cannot avoid it – whether it’s a deliberate decision or the mandate you are given. Ten years ago Charles Stanley Asset Management built a process which is powered by this principle, optimising asset allocation for each risk level and then dynamically adjusting it to enhance beta returns.
We have also adopted inflation-based performance targets. This means we do not base our strategic asset allocation (SAA) around an index and it is far more relevant to investors who judge their wealth compared to what things cost rather than the level of the FTSE 100. Our dynamic process involves adjusting our SAA throughout the year to enhance returns by predicting or interpreting key market events. However, it can be hard to decide on a starting point for the SAA.
We use the Black Litterman model to generate an optimised Global Market Portfolio, then carry out a series of proprietary revisions to create an SAA for each risk profile to which the dynamic process is applied. The dynamic changes do not always add value, but over time we can demonstrate that they make a useful contribution to returns.
Dynamic asset allocation works for both active and passive underlying strategies, but is most powerful with passive where our decision is not diluted by potentially contrary views of the underlying manager.
We interpret outputs differently for some asset types, such as ‘alternatives’, where the active sphere offers more choice. Our active models have recently undergone big changes in this area with the complete disposal of both Jupiter Absolute Return and Standard Life Global Absolute Return Strategies. We switched into Old Mutual Equity Absolute Return (co-managed by Ian Heslop, pictured below), recognising the consistent performance the Old Mutual team has delivered over a number of years and across various market conditions. The fund has a systematic approach with diversification across 600-900 holdings, making it a sensible and well-managed option for market neutral exposure to global equities.
Within equities we still favour the US, seeing the tax and fiscal reforms as continuing positive drivers. It’s a region where active managers find it hard to add value so we tend to use trackers to access the market. Our current choices are the L&G US Index fund and the iShares US Equity Index fund which were selected using our rigorous passive review process. We have also added to emerging markets by starting positions in the Goldman Sachs India Equity fund. Its managers invest in companies of all sizes which have strong or improving fundamentals but are trading at a substantial discount to their intrinsic value. We particularly like the idea that the team will look at smaller companies to unearth new ideas.
Last but not least we remain wary of fixed income, but over the course of this year have harvested a reasonable return from inflation-linked and high yield bonds. The core of our defensive holdings are at the short end of the curve and we like both the Vanguard Short Term Global Bond fund as a passive solution and AXA Sterling Credit Short Duration Bond fund in the active space. It offers good risk management with limited duration risk, while capturing a small spread over short-dated sovereigns.
Overall, we are positive about the medium term outlook for risk assets and do not think the game is over yet, but a dynamic process will certainly bring us increased flexibility as the bull market matures.'