Tilting portfolios to take advantage of specific regions, sectors, style or currencies could help investors extract additional value, but can also be expensive and time consuming.
While some experts believe this could be done efficiently through exchange-traded funds (ETFs), others suggest you leave it to those who are best placed to take advantage of valuation anomalies – the fund managers.
In a recent Trustnet feature, Sven Schubert, senior investment strategist at Vontobel, argued that in today’s markets, buy-and-hold strategies aren’t fit-for-purpose anymore.
“Central bank policy has become far more unpredictable, which means market volatility can also be expected to remain above pre-Covid levels. This usually causes higher macroeconomic volatility (shorter business cycles) as well, all of which means that the buy and hold strategies will not work the same way as they used to,” he wrote.
“A more active investment strategy is required. Moreover, portfolio construction gets more complicated. Our analysis shows that the positive correlation of equities and bonds is likely to remain in place as long as inflation remains well above central bank targets.”
Below, three experts discuss the pros and cons of being more tactical (short-term oriented) rather than strategic (long-term oriented), their approach to short-term calls and the role of actively managed ETFs.
Matthew Quaife, head of multi-asset investment management at Fidelity International said that there is no ‘golden rule’ for taking shorter-term decisions, but it’s important to strike a balance between being responsive to changing market dynamics while avoiding over-trading, which can create a drag on portfolio performance.
“A portfolio’s structural asset mix has the largest impact on long-term returns, so this is the starting point for our asset allocation decisions. Some portfolios will use a strategic asset allocation (SAA) to guide portfolio construction, while others need to take a more flexible approach, depending on their overall objectives,” he said.
“Once a portfolio’s long-term asset mix or design has been determined, tactical asset allocation (TAA) can be used to dynamically alter the weight of particular asset classes or regions to take advantage of shorter-term market conditions and manage risk. Our approach to TAA aims to maximise the breadth of the levers that portfolio managers can pull to express tactical views.”
But there’s a lot of work going into that, as Fidelity’s TAA views are formed from “a combination of quantitative and qualitative research on macroeconomic and market dynamics, including fundamentals, valuations and technicals”.
Pierluigi Ansuinelli, portfolio manager at Franklin Templeton Investment Solutions, Franklin Templeton, agreed that in today’s uncertain environment, SAA needs to be assisted by tactical calls, that can capture different parts of the economic cycle, while being diversified enough to overcome the increasing correlation between stocks and bonds.
“It is said that active management finds its sweet spot during crises because opportunities increase during these phases: a portfolio manager could tilt portfolio composition to take advantage of specific regions, sectors, style and currencies. But rotating an investment portfolio could be expensive and time consuming,” he said.
But now, he argued, it is possible to be active in a smart and efficient way thanks to active ETFs. Traditional passive ETFs are financial instruments widely picked to track specific financial indexes, enabling investors to tilt a portfolio’s composition to react to changing market conditions.
While relatively established in the US, active ETFs are less well-known in the UK. They go further than passives and offer the active work of a team of portfolio managers and analysts selecting securities within a specific index or market.
Due to the fund structure, they are generally cheaper and more easily traded than mutual funds, giving investors more flexibility.
“In other words, active ETFs offer active management, simplicity and transparency at a very low cost,” said Ansuinelli.
“From a portfolio management point of view, there are specific asset classes we are happy to cover with ETFs or also with active ETFs: government bonds and investment grade corporate bonds. In both cases, the benefit of implementing a tactical allocation is compounded by the benefit of extracting additional value from managing yield curve, credit risk and sector diversification.”
Of the opposite views was Shannon Lancaster, fund analyst at Ravenscroft, who wouldn’t deviate from the long-term allocation of a portfolio.
“We buy funds to play a certain role in our portfolios, and unless this changes or valuations suddenly look extremely expensive, we would not be chopping and changing into different areas,” she said.
“Our underlying fund managers are best placed to take advantage of valuation anomalies and very attractive opportunities through bottom-up stock picking, rather than us rotating the portfolio to achieve short-term performance goals.”
“It is also very hard to call the right trading time in and out of positions. We are firm believers that it comes down to ‘time in the market’ rather than ‘timing the market’.”