Asset allocation
Proactive focuses first on asset allocation across multiple asset classes and then on asset selection within each asset class.
Asset allocation means of “not putting all your eggs in one basket. Asset allocation is the process of investing a portfolio across a variety of different types of assets such as shares, property or fixed interest. The price of each of these asset types behaves differently in different market conditions. They do not all rise or fall together. Holding a diversified or multi-asset class portfolio is a way of achieving returns while managing risk.
Asset Allocation is the major driver of returns over time while asset selection can be an important source of added returns. The decision about the proportions that are held in each asset type or class is very important. Portfolios with different asset allocations will have significantly different returns over time.
Independent academic studies over the last 35 years have shown that more than 80% of the difference in returns on portfolios can be explained by the difference in their asset allocations, whereas variations in the weightings to individual investments within each asset class were shown to deliver about 10% to 20% of the variations in portfolio returns.
Strategic and Dynamic Asset Allocation
The asset allocation of portfolios is set and managed in two stages using two distinctly different timescales: Strategic and Dynamic.
Strategic Asset Allocation (SAA)
The Strategic Asset Allocation (SAA) for each portfolio is set using a ten-year forecast of asset returns in each of the major asset classes using a ten-year time scale. Asset class return and inflation forecasts are sourced from at least two independent sources. The return forecasts are reviewed annually but the Strategic Asset Allocation and the expected margin of return over inflation will not necessarily change. In practice these have been stable over a number of years.
We firstly set the long term strategic asset allocation benchmarks and ranges for each Portfolio using asset class return forecasts of returns over the next ten years – for a number of economic and financial market scenarios. This is referred to as Strategic Asset Allocation and the Asset Allocation Ranges.
Then within the Asset Allocation ranges we proactively shift the asset allocation to each asset class over time. This is based on analysis of whether particular asset markets are over or under priced. We also take into account their medium-term price momentum as well as a systematic evaluation of qualitative factors such as monetary policy, fiscal policy and geopolitical factors that may affect financial markets and asset returns. This is called Dynamic Asset Allocation.
Dynamic Asset Allocation (DAA)
The actual asset allocation of the portfolio is managed dynamically over time. This entails shifting the allocation between asset classes in to improve portfolio returns or reduce the volatility of portfolio returns over a shorter time period of up between one and five years. This is done via regular review of investment market conditions in each of the major asset classes using expert inputs from a number of experienced sources.
Dynamic Asset Allocation reviews are conducted monthly with changes in asset allocation taking place up to several times each year. The process involves:
1. Assessing Valuation for each asset class; we assess where the current market prices are compared with the long-term assessment of the fair price for that asset class.
2. Assessing Momentum Indicators as a guide to whether current price trends will continue or are about to change
3. Overlaying a Qualitative assessment by the Investment Committee of the economic, political, fiscal policy and monetary policy factors that may affect future asset prices.
The portfolio asset allocation weightings within the allowable ranges are then derived from these assessments. The further the asset class is away from fair value, the greater the shift away from the long-term benchmark asset allocation.
Asset allocation is managed in the same way for each of the two series of SMAs.
Asset Selection
The selection of assets within each asset class is carried out systematically for all portfolios.
For the Proactive Portfolios SMAs, which invest in securities listed on the ASX, Proactive selects securities in each asset class using a combination of:
- Value-based criteria such as a minimum yield
- Stock ratings from expert sources such as Morningstar
- Risk management assessments using a proprietary process of the Investment Committee together with the combined experience of its members.
For the Proactive Managed Fund Model SMAs, which invest in wholesale managed funds, Proactive selects funds in each asset class using a combination of:
- Quantitative selection criteria such as the Information Ratio and Sharpe Ratio of each fund over five year period
- Qualitative assessments from independent research sources such as Morningstar.
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