Under the bonnet of Dynamic Asset Allocation
An active approach to asset allocation provides greater flexibility to invest in a broad range of markets- from European equities to inflation-linked bonds and commodities, corn to soybeans, currency to high-yield credit.
The AMP Capital Dynamic Markets Fund uses active asset allocation to take advantage of mispriced investment opportunities from around the world and deliver a total return objective of CPI* + 4.5% over a rolling 5 year time horizon .
Unlike more traditional diversified funds, we have greater flexibility to invest in a broad range of markets – from European equities to inflation-linked bonds and commodities, corn to soybeans, currency to high-yield credit.
We do this using our Dynamic Asset Allocation (DAA) process which has been developed over many years at AMP Capital and been tried and tested through many market cycles. The process starts with our Investment Strategy and Dynamic Markets team working out expected returns for each asset class over a 5 year time period.
From there we create a medium-term score of each asset class using five drivers, three fundamental and two market, which are weighted based on where we are in the economic cycle.
The Expected Returns and asset class scores are combined to create a Merged Return, which highlights whether the medium-term performance of an asset class is expected to be higher or lower than the long-term Expected Return.
This ongoing investment process helps us to manage the portfolio’s risk and return characteristics.
Here are two examples of how DAA has helped us to generate returns and manage risk within the portfolio.
Adding value through China A
In 2012, our DAA process told us that China A shares looked very cheap, and these attractive valuations were supported by our liquidity driver, as the People’s Bank of China was loosening monetary policy.
We initiated a small position in 2012, and then added to it in 2013, given the positive signals our process was indicating around further favourable monetary policy conditions.
The portfolio at this time had a 10 per cent exposure to China A shares, contributing around 4 per cent to the Fund’s overall return, before we changed position in early 2015.
Taking profits, reducing risk
The China A shares position performed strongly from 2013 until mid-2015, and while the DAA valuation score for China A shares didn’t reach the expensive levels of 2012, it was clear they weren’t as attractive as they once were from a valuation perspective.
We also became concerned with other factors, especially the sentiment driver, which was showing signs of over-optimism. Over-optimism was evident from the number of new A-share accounts being opened and the rapid rise in margin lending, as investors rushed into the market assuming these strong returns would continue forever.
While the valuation score wasn’t negative, the sentiment driver was certainly providing a negative signal and was a key factor in the decision to halve our allocation to China A shares.
The allocation was also making a large contribution to the portfolio’s risk at this time, so this move also aimed at reducing some of the concentration risk in the portfolio.
We continue to hold exposure to China A shares as our process still views them favourably, with the better data coming out of China and the stabilising of US manufacturing data. The investment team will continue to monitor this position and utilise the DAA process to observe any changes.
Reducing risk through volatility futures
Before the Brexit referendum in June, there was a significant risk that this market event could impact the portfolio’s short-term returns.
Despite pre-polls showing the outcome was too close to call, we felt markets were showing signs of complacency. This was highlighted by sharemarkets rallying into the vote and implied volatility being very low.
While most assumed a Remain outcome was almost certain, the investment team determined that a long exposure to volatility futures would be an effective hedge against an adverse outcome.
In situations like this, the investment team looks for exposures that have a strong negative correlation with equities, and are not too expensive or crowded.
Volatility futures ticked both boxes and an allocation of around 4.5 per cent of the portfolio was made to help reduce the overall level of portfolio risk.
A good decision, given the result
On the day of Brexit, these positions contributed over 1 per cent to the portfolio’s performance.
Along with providing an effective portfolio hedge, these positions also helped to minimise the portfolio’s drawdown, as equities sold off after the vote.
Once the Brexit decision was confirmed and volatility had spiked significantly, we exited the position, given there was no further catalyst for volatility to spike further.
Later, we allocated the proceeds to growth asset classes like equities and commodities, as a way to capitalise on the post-Brexit recovery in investment markets.
Asset allocation remains vital
Using the Dynamic Asset Allocation approach to maximise returns when markets are performing, yet still being able to protect our gains when markets become vulnerable, has helped us to deliver on our long-term investment outcome.
- Returns are not guaranteed – there is no guarantee that the fund’s investment strategy will be successful or that the investment objective will be achieved
- Asset allocation - there is no guarantee that the Fund’s asset allocation strategy will provide positive investment performance at all stages of the investment cycle
- Share market investment – adverse share market movements could result in capital losses, particularly over the shorter term
- Liquidity – although the units are quoted on the AQUA market of the ASX, there can be no assurance that there will be a liquid market for units, and no assurance that there will be a liquid market for the Fund’s investments
- ASX trading price – the trading price of units on the ASX may differ from the Net Asset Value (NAV) per unit and the indicative NAV (iNAV)
- Market making – as the responsible entity, BetaShares, acts a market maker in the Units on behalf of the fund, the fund will bear the cost and risk of these market making activities
* The Reserve Bank of Australia inflation rate (Consumer Price Index) – trimmed mean
About the author
Sam Amora, is the investment strategist and assistant portfolio manager of the Dynamic Markets Fund.
Access up to 80 global opportunities in a single trade
In a world where market volatility and low growth are the new norm, asset allocation is more important than ever. However accessing asset classes globally and outside of the usual places in order to do this is difficult.
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