Earlier this year, 10X Investments deviated from the strategic asset allocation in its multi-asset strategies for the first time since they were launched in 2007.
‘After markets rallied in January, we saw risk in growth assets both from a South African and US perspective,’ said the firm’s head of multi-asset funds, Chris Eddy. ‘You saw equity market valuations increase at the same time that bond yields were ratcheting higher. So we decided to de-risk slightly and sold some equity for cash.’
This was the first reallocation decision that Eddy, together with the firm’s CIO Anton Eser, had made under 10X’s evolved investment approach.
Until last year, the firm’s multi-asset funds had been run purely on a static asset allocation basis.
‘Our process was always grounded in historical data,’ Eddy (pictured below) said. ‘We look back over last 120 years of market data, and use that to set the strategic asset allocation for each of the portfolios.’
However, Eser said that the changes to the Regulation 28 limits were a catalyst for reconsidering whether setting that strategic asset allocation and sticking to it under all market conditions was still the most prudent approach.
‘We spend a lot of time defining the strategic asset allocation based on those 120 years of data,’ he said. ‘But you can’t build a portfolio that is purely backwards-looking, because that would lead to buying German bunds at negative 20bps two years ago.
‘The most important driver of returns over the next five to 10 years is the current valuation – the price you pay.’
10X wanted to build a model that took valuation into consideration in its portfolio construction, but without compromising the natural long-term approach of a passive multi-asset strategy. They are, therefore, not making constant tactical asset allocation decisions based on expectations six to 12 months out. They are thinking in terms of expected returns over the next five to 10 years, based on current starting valuations.
‘The long-term data that we use for our strategic asset allocation is really important to ground our process in terms of the outcome we are looking to deliver,’ Eddy said. ‘But incorporating the current market environment adds a forward-looking view so that we can actually deliver those outcomes to clients.’
As at the end of March, for example, the S&P 500 was trading on a CAPE ratio of close to 27 times. That is near the top of its range. Historically, from these levels, the market has delivered relatively muted real returns over the following decade.
According to Eddy, the South African equity market is trading on a CAPE ratio of 15 times, which is around its historical average.
‘That implies that we should expect real returns in the region of 7.3%, which is what we have seen from South African equities over the long-term time horizon,’ he said. ‘But if you compare that to what is on offer from bonds, which we think is inflation plus 5.5%, it contextualises the attractive opportunity available in South African fixed income.
‘The additional return above bonds, that you are being rewarded for taking on equity risk, is less than 2%, which doesn’t look that attractive.’
This informs 10X’s more defensive stance in its multi-asset portfolios. However, any shifts to positioning will not be more than 5% away from the strategic asset allocation between growth and defensive asset classes.
‘Although we will utilise credit, for example, as a growth allocation, so it’s not just pure equity in that pot,’ Eddy said.
Eser added that it is also important to know at what point equity markets become attractive again and it is worth shifting the balance back towards growth assets.
‘It’s not only necessary to establish what the valuation is currently, but at what point it becomes fair value or attractive again,’ he said. ‘By applying stress testing to current valuations, we set a level at which we would become buyers again.’
Importantly, this is rules-based.
‘In active management, you might have targets but when the market gets there, there will still be a whole lot of reasons not to buy,’ Eser said. ‘So establishing those rules for us is important.’
This article by Patrick Cairns was originally published by Citywire entitled “How 10X has changed it’s multi-asset investment approach”.