10X Investments does not believe tactical asset allocation has consistent value in portfolio construction over the long term.

‘We don’t believe tactical asset allocation has consistent value in portfolio construction over long periods,’ 10X Investments head of client solutions Chris Rule said during a panel discussion at the 10X Think Indexing conference.

‘We see a clear misunderstanding in the market that strategic asset allocation is static. Holding an asset allocation in a strategic fashion means that you cannot move it,’ Rule added. ‘I see some confusion in the market around what tactical asset allocation is, and anything conceived as a shift in strategic is [seen as] tactical, but it’s not. It’s managing for four- or five-year horizons,’ Rule said.

‘You can manage for forward risk and consistency of outcomes by strategically changing your asset allocation based on a number of capital markets assumptions, valuations and within the constraints of the environment,’ he added. ‘Strategic does not mean static. It doesn’t mean we set and forget. But tactically looking forward to where we see market valuation bets driving alpha in the next six months is not the business we are in. We don’t use that as a tool inside our construction portfolio set,’ Rule (pictured below) added.

Equilibrium Investment Management head Florbela Yates said the biggest portfolio volatility comes from asset class choices.

‘We use strategic asset allocation and a building block approach. All our research shows that getting your asset allocation right impacts your short- and long-term outcomes,’ she added.

Yates said strategic asset allocation is a cornerstone of portfolio construction.

‘Strategic asset allocation does not mean it is static. We make forward-looking assumptions about what we expect for various asset classes and certain strategies,’ she said. ‘We don’t change all the time, but we constantly review it,’ she added. ‘Different environments dictate different ways to execute on each asset class, including whether it’s passive or active,’ Yates said.

Equilibrium is mindful of risk when building portfolios.

‘Our main aim as an asset manager is to keep our clients invested. We don’t want them to disinvest if there is too much volatility,’ Yates (pictured below) said.

‘We spend a lot of time with our advisers explaining to them what to expect from portfolios, so in times of increased volatility, our advisers tend not to panic,’ she added.

Victoria Reuvers, managing director of Morningstar Investment Management South Africa, said asset allocation drives returns.

‘The challenge for portfolios at the moment is although we have great real returns on cash and bonds, the correlation between bonds and equities has increased to the point that they are no longer the protector, or they don’t reduce volatility in portfolios. [Instead] they add to volatility,’ she added. ‘Strategic asset allocation is a great anchor through the cycle,’ Reuvers said.

Paul Fouché, CIO and co-founder of New Road Capital (NRC), said all of NRC’s modelling and work goes into asset allocation. NRC starts with bonds when determining asset allocation.

‘What can you get out of bonds? You have a yield to anchor yourself on. We start there, and we work backwards. Equities are impossible to forecast,’ he added.

However, Morningstar’s Reuvers (pictured below) disagreed with Fouché, saying it was possible to forecast equity valuations.

On the increase in the offshore limit, Fouché said NRC tried to manage volatility in its portfolios, and taking on too much offshore exposure can unnecessarily increase volatility.

‘I don’t think it is worth the volatility to go to 45%,’ he added.

Depending on a portfolio’s risk profile, NRC has offshore allocations between the high 20% to mid-30%.

‘That is our sweet spot,’ Fouché added.

Rule said the Regulation 28 offshore allowance increase allowed 10X to diversify their portfolios further. 10X uses currency hedging to control volatility.

On the other hand, Fouché said NRC believes in offshore currency exposure.

‘You don’t want to hedge most of it. In times of crisis, it works in your favour [as the rand weakens],’ he added.

RMI Investment Managers portfolio executive Zama Zulu, who chaired the discussion, said South African-based managers now had more competitors due to the increased offshore exposure.

Reuvers said Morningstar looked at all managers through the same lens regardless of their location.

‘Geography is quite meaningless. We appreciate the cost and manpower it takes to build great capability and the shortage of skills and talent in South Africa,’ she added. ‘The increase in the offshore limit to 45% was a gift from the government. We all thought it was a mistake,’ Reuvers said.

Equilibrium’s Yates said the change to Regulation 28 created opportunities and changes.

‘The first opportunity is allowing us to look at portfolios holistically,’ she said. ‘Certain asset classes lend themselves more to active and others to passive. We look for value, quality, and growth-type strategies within South African equities,’ Yates said.

Equilibrium sources the South African component of their portfolios from South African managers and the global exposure from offshore managers.

‘When it comes to quality – we have such a small universe in South Africa – it is probably better sourced from offshore,’ Yates said.

She said Equilibrium looks worldwide for the best specialist managers.


Passive investing

Reuvers said Morningstar likes passive investing.

‘Our starting point is always to build a portfolio with passive building blocks because it gives you a cheap entry point and broad diversification,’ she said.

Yates said Equilibrium uses a combination of active, passive and small beta.

She said Equilibrium had mainly accessed offshore assets through passive vehicles until recently. One of the reasons for this is that the South African investment industry had platform constraints.

‘You have to invest in collective investment schemes. If you want to invest in an offshore fund on a local platform, you must pay a feeder fund fee,’ Yates said. ‘We use a combination of active and passive and tend to use more passive in offshore hard currency [portfolios]. In the equity area, we use much more active,’ she added.

Fouché said NRC portfolios use a lot of thematic-based ETFs exposed, for example, to semiconductors or Nasdaq-listed companies.

‘All of our asset allocations are passive except local income – it is the only place where we can get consistent outperformance versus the benchmark,’ he added.

Fouché said ETFs provide many options, low costs and transparency.


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