Asset Allocation and
Paul Moody – Head of Investment
This document is for investment professionals only. The content is not to be
viewed by or used with retail investors.
The importance of asset allocation
The problems with traditional approaches
Currency and tactical asset allocation overlays
Asset Allocation: Harder than it looks!
N. America Asia Pac Property UK Credit Global FI Em Mkts Em Mkts Japan Em Mkts Em Mkts
29% 84% 11% 7% 17% 56% 26% 45% 33% 40%
Europe Em Mkts UK Credit Property Property Asia Pac Property Em Mkts Asia Pac Asia Pac
25% 66% 10% 7% 10% 44% 19% 35% 30% 37%
World Japan O/S Govt O/S Govt UK Credit World World Europe Europe World
25% 47% 8% 5% 9% 34% 15% 29% 22% 10%
UK Credit Europe Cash Cash O/S Govt N. America Europe Asia Pac World Global FI
15% 37% 5% 4% 8% 30% 13% 27% 21% 9%
UK Equity World Global FI Global FI Cash Japan UK Equity UK Equity Property N. America
14% 25% 3% 2% 3% 23% 13% 22% 18% 8%
Global FI UK Equity Europe Em Mkts Em Mkts Europe N. America Property UK Equity Europe 50%
14% 24% -1% -2% -6% 21% 11% 19% 17% 7%
Property N. America UK Equity Asia Pac Asia Pac UK Equity Japan World N. America UK Equity
12% 23% -6% -4% -14% 21% 11% 10% 7% 5%
O/S Govt Property N. America N. America Japan Global FI Global FI UK Credit Japan Cash
9% 14% -12% -12% -19% 13% 9% 9% 7.35% 5%
Cash Cash World UK Equity World Property Asia Pac N. America Global FI O/S Govt
6% 4% -13% -13% -20% 11% 7% -7% 7% 4%
Japan UK Credit Japan World N. America UK Credit UK Credit Cash Cash UK Credit
-9% 0.1% -20% -17% -22% 0.8% 7% 4% 4% 0.4%
Asia Pac O/S Govt Em Mkts Europe UK Equity Cash O/S Govt O/S Govt UK Credit Property
-9% -1% -31% -18% -23% 3% 5% 4% 0.8% -5%
Em Mkts Global FI Asia Pac Japan Europe O/S Govt Cash Global FI O/S Govt Japan
-25% -5% -36% -19% -32% 2% 4% -4% 0.7% -10%
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Improve overall risk budget by combining less correlated assets
Return Return Return
Risk Risk Risk
Asset Class A Asset Class B Combined returns of
asset class A + B
Our process considers the asset class returns, correlation and consequently the
Correlation is the degree to which two assets have a tendency to move together
ranging from (1) perfect correlation to (-1) perfect inverse correlation
The problems with traditional asset allocation approaches
Peer group benchmarks results in:
herd-like mentality with
constrained asset allocation
In practice this has resulted in over
reliance on equities which:
creates problems because of
Are rarely diversified across markets
inconsistent with regulatory valuation requirements
Strategic Asset allocation has a major influence on investment performance
Risk-return Asset Historic
target allocation volatilities
Evidence shows asset allocation contributes up to 95% of return variance*
* Brinson et al., (1986 & 1991) referenced in J Annaert et al Journal of Banking and finance (2005) 661-680
and Blake et al., (1999) referenced in J Annaert et al Journal of Banking and finance (2005) 661-680 Page 7
So what are the main alternatives?
Currency and tactical asset allocation overlays
A consumption asset, not a financial asset
Access via commodity (index) futures/Exchange Traded Funds
Choice of index crucial
Gorton and Rouwenhorst (2006): commodities have historically provided:
equity returns at lower level of risk and with positive skew
diversification from equity returns
Sources of return
spot prices driven by nominal GDP and demand/supply balance
backwardation and downward sloping futures curve: positive “roll”
Most popular commodity indices: composition variations
69.4 S&P Goldman Sachs Commodity Index
Dow Jones - AIG Commodity index
% of index
10.8 9.1 9.2
Energy Industrial metals Precious metals Agriculture Livestock
Source: Thompson Financial constituents snap shot as at end-2007
Currency and tactical asset allocation overlay strategies
generate returns from long/short positions across global equity, bond and
exploits inefficiencies in asset prices resulting from:
investor sentiment such as excessive optimism or pessimism
structural anomalies such as legislation, tax or market habit
non profit-maximising market participants
Long term capital intensive projects that fulfil major social and/or economic
Increasingly PFI financed given public sector spending constraints
Economic infrastructure, eg utilities, toll roads
Social infrastructure, eg hospitals, prisons
As regulated natural monopolies/oligopolies offer bond-plus characteristics:
Relatively high and stable longer term inflation linked cash flows
Infrastructure assets are ideal for matching long dated liabilities
What is it?
Venture capital funds: provide start up and development equity capital
buy into companies cheaply, restructure/change their business model,
buy stake in quoted companies, act as friendly activist…
…and sell stake to the market or trade buyer at a sizeable profit
What is the objective?
generate a return in excess of that from quoted equity
Private Equity has divergent performance
Performance derives from combination of asset class and skill set:
Buyout funds outperform venture capital funds*
Returns heavily skewed towards top performing funds*:
22.9% top quartile IRR
10.6% mean IRR
0.5% median IRR
Evidence of performance persistency*
Apparent diversification results from Private Equity values being booked at cost
Manager and strategy selection is crucial – increasingly accessed via fund-of-
* Net Pooled Returns for 279 Private Equity Funds formed 1980 - 2005.
Source: Thomson Financial, European Private Equity and Venture Capital Association. 27 July 2006.
What is a Hedge Fund?
Private limited partnership/unregulated pooled investment fund
administered by professional investment managers
What do Hedge Funds seek to do?
Generate absolute returns, ie positive returns independent of market
By employing wide range of investment strategies, techniques and
Are all hedge funds the same?
No agreed definition of what constitutes a hedge fund: very
Not an asset class: more of a skill set as low correlation between and
Most combine specific strategy with leverage to magnify returns - few
are truly hedging market risk as name implies
Around 8,000 known hedge funds managing total assets c.$1.5tn –
many others escape scrutiny
Originally for HNWIs: now institutional investors driving growth
Optimised portfolio including fund manager skill
Risk and return
Optimised portfolio including fund
manager skill EM Equities
8.0% assets and
manager skill UK Equities
7.0% CAPS balanced managed
6.0% UK Cash Commodities
2% 7% 12% 17% 22% 27% 32%
Resulting in a highly diversified portfolio targeting equity-like returns
for bond-like risk
Asset allocation is the main driver of investment returns
Unconstrained asset allocation makes sense
The are an ever increasing number of exotic and alternative asset classes
It makes sense to consider the widest array of asset classes
Except where stated as otherwise, the source of all information is Morley as at 31 May 2008.
Any future returns and opinions expressed are based on our internal forecasts and should not be relied
upon as indicating any guarantee of return from an investment with Morley. No part of this document is
intended to constitute advice of any nature nor should any part be construed as a recommendation to
purchase or sell stocks.
Where past performance has been illustrated it is not intended to be a guide to the future.
When investing with Morley investors should be aware that the value of an investment and any income
from it may go down as well as up. Investors may not get back the original amount invested.
Morley is a business name of Morley Fund Management Limited, registered in England No. 1151805. Registered Office: No. 1 Poultry, London
EC2R 8EJ. Authorised and regulated in the UK by the Financial Services Authority and a member of the Investment Management Association.
Morley is also a business name of Morley Fund Services Limited and Morley Pooled Pensions Limited. All are Aviva companies.
Contact us at Morley Fund Management Limited, No. 1 Poultry, London EC2R 8EJ. MFM/MFM/08/xxx
A particular slide catching your eye?
Clipping is a handy way to collect important slides you want to go back to later.