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Why Multi-Asset Thinking Works Best
Investors often focus on individual parts of their portfolios, like a particular country or style of investment. That thinking could be hurting their results.
Date: October 6, 2017
In today’s low-rate environment, it can be all too easy to put most of one’s effort into finding great individual investments, funds or components.
But having good components alone is not sufficient, says Todd Mattina, Chief Economist and Strategist of the Mackenzie Asset Allocation team. “Investors who want to maximize long-term returns without undue risk need to be thinking more about how their overall portfolio fits together and less about the performance of an individual fund manager," he says. "In our minds, investors spend too much time focusing on finding the best investments and not enough time thinking about their total portfolio.”
Studies have showed that asset allocation – not stock picking – drives more than 90 percent of the variation in total portfolio returns. “Stock picking is really just the remaining tip of the iceberg,” he says.
Pension fund approach
“At Mackenzie Investments, asset allocation is a large-scale effort,” says Alain Bergeron, Senior Vice-President, Portfolio Manager and Head of the Asset Allocation team. The Toronto-based firm, which serves more than one million clients, adheres to a true multi-asset portfolio management approach that incorporates some of the best practices from leading institutional pension funds.
Prior to joining the Mackenzie Asset Allocation team, both Bergeron and Mattina spent many years managing portfolios at the Canada Pension Plan Investment Board (CPPIB), ranked as one of the 10 largest retirement funds in the world, with assets projected to reach $476-billion by 2025.
“The best practices of asset allocation are typically implemented by the world’s largest and most sophisticated pension funds. And these best practices have evolved significantly in the last few years,” says Bergeron. “What we’re trying to do is bring the benefits of this thinking to the average Canadian investor.”
“One troubling trend in portfolio construction right now is the overriding assumption that funds with high active share – a measure of the percentage of stock holdings in a manager’s portfolio that differ from the benchmark index – are always desirable,” says Mattina.
“Combining various funds with high active share can cause stock characteristics to overlap – these funds can sometimes crowd into the same common factors – and that might result in the investor taking on more risk than they should,” Bergeron says.
“The worst part is that they may not be aware of it, nor is it deliberately done by any of the portfolio managers operating in isolation,” explains Bergeron. “An added complexity to managing total risk is that the characteristics of the underlying funds will often change over time, making interactions more difficult to handle.” To that end, Mackenzie Investments has spent millions of dollars developing software that can track all these exposures in real time. “We’ve made significant investments in our technologies to bring our asset allocations to the next level,” he says.
Overlooked asset classes
Another problem with taking an individual component approach is that attractive asset classes often get overlooked. In a low-yield environment, for instance, many investors have avoided government bonds for the simple reason that they yield less than other types of securities. Mattina says that avoidance is a mistake.
“We believe that government bonds are important assets to own,” he says. “They provide great diversification in a recession or during times of deflation. It’s throughout a crisis that investors need this type of diversification the most.”
Many investors are also diversifying into alternatives, such as real estate or commodities, or other assets that are correlated to equities. However, just owning alternatives for the sake of owning them isn’t wise. Some of these offerings are traditional investments repackaged with an alternative label. “If you look through the alternative labels and understand the true economic exposures, only then can you see if you’re helping or hurting yourself,” says Bergeron.
Pointing to his own experience at the CPPIB, Bergeron stresses the need to understand the look-through exposures of owning an alternative asset such as real estate. A large part of a real estate investment’s return and risk could be replicated by holding a combination of government bonds and equities. In such cases, the investment may not add as much diversification as many believe.
“So investors should really consult with a professional financial advisor when considering adding these investments to their porfolios,” advises Bergeron.
Those investors who focus on total portfolio management will also end up factoring in things like currencies – something that the average investor (and even fund manager) doesn't typically think much about – into their portfolio decisions. Mackenzie has found that foreign currencies, often an unavoidable byproduct of global portfolio diversification, can provide a great opportunity to both reduce risk and improve returns.
“From a strategic portfolio perspective, it’s very important,” says Mattina. “For example, the U.S. dollar and Japanese yen often trade against equity movements, so by having exposure to the U.S. dollar and the yen, a Canadian investor gets natural diversification.”
“Unfortunately for retail investors, currencies are often not managed by currency professionals. And the few who truly have the expertise tend to focus only on the U.S. dollar,” says Bergeron.
“The product choices around currency are often too blunt, offering static hedging ratios and identical hedging ratios across currencies, neither of which is optimal from a total portfolio perspective,” he adds. “This leaves a lot of potential value on the table.”
Rigorous valuation work – a key building block in Mackenzie’s multi-asset total portfolio management approach – is something else that shouldn’t be left to less experienced managers, who often rely on metrics such as price-to-earnings ratios, says Mattina. While useful, such simplistic valuation measures can potentially signal attractive value opportunities at a time when other fundamentals suggest otherwise.
When it comes down to it, taking a total portfolio approach, as Mackenzie Investments does, emphasizes long-term investing and the importance of preserving capital through changing market environments.
“It may sound controversial, but a lot of what we’re saying is just common thinking and common practice at the large and sophisticated multi-hundred-billion pension funds,” Bergeron says. “It’s amazing that more people have not embraced this approach yet.”
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