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Value of manager selection and asset allocation in a portfolio

02 September 2021 Luigi Marinus, Portfolio Manager at PPS Investments

When building a portfolio, you may be faced with many important decisions. Two key components are selecting asset managers and allocating to assets in a way that is aligned to your investment goals, risk profile and time horizon. Determining these elements in your portfolio, contributes to how diversified your portfolio is and the likelihood of achieving your investment goals. But how does one go about this?

One option, is to consider investing with a multi-manager that adds value by selecting and blending asset managers, as well as determine the suitable asset allocation that offers the highest likelihood of achieving the desired investment outcomes.

To demonstrate the value added through asset allocation and manager selection by a multi-manager, let me use the PPS Conservative Fund of Funds as a practical example.

The PPS Conservative Fund of Funds has a primary benchmark of inflation +2% and a secondary hurdle of being competitive in the peer group. It is therefore constructed in two parts; one that uses single asset class funds to target a long-term asset allocation (building block component) and one that uses multi-asset funds to outperform peers (multi-asset component). The split of these two components is shown below:

PPS CONSERVATIVE FUND OF FUNDS

FUND/ASSET CLASS

HOUSEVIEW

STRATEGIC ASSET ALLOCATION

TACTICAL ASSET ALLOCATION

BUILDING BLOCK COMPONENT

Local Equity Fund

Neutral

7.50%

7.50%

Local Property Fund

Max Underweight

3.75%

1.25%

Local Bond Fund

Max Overweight

16.25%

22.50%

Local Cash Fund

Max Underweight

16.25%

11.25%

Global Equity Fund

Max Overweight

3.75%

7.50%

Global Property Fund

Overweight

0.00%

0.00%

Global Bond Fund

Max Underweight

2.50%

0.00%

Global Cash Fund

Underweight

0.00%

0.00%

 

 

50.00%

50.00%

MULTI-ASSET COMPONENT

Multi-Asset Low Fund 1

Equal split

16.66%

16.66%

Multi-Asset Low Fund 2

Equal split

16.67%

16.67%

Multi-Asset Low Fund 3

Equal split

16.67%

16.67%

 

 

50.00%

50.00%

 

 

100.00%

100.00%

 

Source: PPS Investments

The building block component is made up of funds with a single asset class so that the appropriate asset allocation can be applied to this part of the PPS Conservative Fund of Funds. The strategic asset allocation (SAA) is the long-term allocation that has been modelled by the team to achieve the inflation target with the suitable level of risk for the category. This allocation is remodelled annually but seldom changes due to the long-term nature of the analysis.

The tactical asset allocation (TAA) is applied more regularly and adjusts based on the house view for each asset class. The house view is assessed at least quarterly where an analysis of the valuation, macroeconomic effect and momentum of each asset class is analysed. This in-depth analysis informs the relative weight of each asset class and therefore the allocation to each asset class. Although this does not mean the asset allocation changes quarterly, the consistent process ensures that the house view is assessed regularly and the allocation matches the most recent information available. By applying this process, the team has positively added to the fund performance attributable to asset allocation.

The multi-asset component is made up of multi-asset funds with the peer relative benchmark of the category. These underlying managers independently apply their asset allocation, which may or may not differ from each other, or the building block component of the fund. Importantly, as these views are independent, it improves the overall diversification of the PPS Conservative Fund of Funds, resulting in a more consistent performance signature over time.

Manager selection is applicable in both the building block and multi-asset components of the PPS Conservative Fund of Funds. In the building block, each of the single asset funds may have one or more managers depending on the diversification benefit of that asset class. The local equity fund has three underlying managers, while local cash fund has only one underlying manager. There are more investment styles and a wider possibility of returns in the local equity space, than in local cash, hence the greater benefit of diversification. In the multi-asset component, the underlying funds have the same target, but how they achieve that varies on their risk profile, investment style and how active they are.

In manager selection, the first step is therefore to identify the managers that would be suitable for inclusion in a Fund of Funds by quantitative and qualitative assessments. This evaluates the organisation’s structure, experience and expertise of the investment decision makers, the suitability of the investment approach and the consistency of performance aligned to their style over time. The second step is to effectively combine these exceptional managers with the aim to blend the different styles that deliver outperformance at different times. It is therefore not unusual, and should be expected, that not all underlying funds will outperform peers over all short-term periods. The aim with manager selection is not to predict which managers are going to perform best in the immediate future, but to invest with a combination of managers that will deliver a competitive return regardless of the economic environment. This mindset ensures that all manager selection decisions are thoroughly analysed and continually reassessed with regular meetings with these managers.

Adding value over time

The long-term performance is testament to the value that manager selection and asset allocation have added to the PPS Conservative Fund of Funds over time. While the attribute that adds more value varies from time to time, a multi-management investment team adds value by consistently applying a thorough investment process that, over time, results in the desired outcome for the Fund of Funds.

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