Dynamic asset allocation adding value in market volatility

How did dynamic asset allocation add value to our portfolios during the COVID-19 market volatility?

We believe that markets can dislocate as extreme fear and greed sets in. Let’s take a look at how dynamic tilts have added value to our client’s managed portfolios during the ongoing COVID-19 market volatility. In March and April, we added to our equity and credit positions in one of the most volatile periods in financial market history. We also reduced our hedges (designed to protect portfolios) in our dynamic real return strategies.

Importantly in this article, we want to highlight the global process that led to the strong signals to add risk. As fear gripped financial markets our ability to understand the cycle, valuations and sentiment of asset classes was critical. Although these examples may seem simple in hindsight, there was intense debate and detailed risk analysis needed. The process was already set in place before the crisis and has been continually enhanced over the last several years.

How the process works:

  • We take well-researched insights from our globally based sector specialists and strategists. It’s important for each specialist team (e.g. fixed income or equities) to state their convictions and general time horizons.
  • Portfolio managers update their model portfolios and undergo detailed risk budgeting and scenario analysis.
  • Finally, trades are implemented by specialist implementation teams after receiving trade instructions from portfolio managers.

The trades below were consistently applied in terms of theme and direction across Australian multi-asset funds and global multi-asset funds. This process was similarly applied by portfolio managers ('working from home') in Seattle, New York, London and Sydney.

For a brief refresher, this diagram illustrates the structure of the Australian managed portfolios. The orange bar shows the allocation to the real return strategies for each model. This is where most of the dynamic asset allocation tilts were implemented.

Dynamic asset allocation adding value in market volatility chart 1
(Click image to enlarge)

* Russell Investments Global Opportunties Fund

We want to highlight five articles from our specialist strategists and sector leads. I will summarise the key points and the action we undertook.

  1. 26 March 2020: Andrew Pease - Outlook Q2 Update: Cycle, further interrupted
    • Equities and credit are attractively priced as markets have panicked. Add to these asset classes.
    • What did we do? We bought Australian shares, global listed property and high yield debt in the dynamic core fund. We reduced our hedges too.
  2. 3 April 2020: Keith Brakebill - When it comes to fixed income, time is on your side. And so is the Fed.
    • ‘Pound the table’ bullish confidence in credit.
    • What did we do? We bought investment grade credit in our fixed income sector portfolios.
  3. 18 June 2020: Adam Smears – Fixed Income Survey: The quarter of quarters. A COVID-19 Special
    • We surveyed our external managers and they too believe that credit is bullish opportunity
    • What did we do? We continue to hold onto our credit positions and amplified certain sectors that have not rebounded as strongly.
  4. 24 June 2020: Andrew Pease - 2020 Global Market Outlook – Q3 update: The great reopening
    • Reduce positions that have rebounded strongly
    • What did we do? We trimmed US equities.
  5. 2 July 2020: Megan Roach – What is today’s opportunity in small cap stocks?
    • Small cap has underperformed and there is a compelling case for a tactical opportunity
    • What did we do? We added to small cap stocks from large cap in the managed portfolios.

Conclusion: The COVID-19 crisis has been challenging for investors. Our dynamic asset allocation process has been enhanced and refined over the last several years. This was one of the most extreme tests of the process. We show that our ability to invest in dislocated markets was positive and continues to add value. Looking forward, as Andrew Pease states in the latest Q3 market update our outlook is more neutral. Right now, we hold overweights to credit but have pared back our equity risk. We must be comfortable in being close to neutral to our strategic asset allocations and wait patiently for more opportunities.