Produced in partnership with Colonial First State.
Wealth management firm, Colonial First State is considering an out-of-cycle strategic asset allocation (SAA) review, amidst extreme and unpredictable market conditions.
Ordinarily, the firm conducts a formal SAA review every two to three years and makes dynamic asset allocation (DAA) calls through market cycles, based on changes to market conditions and macroeconomic factors, but these are not ordinary times, according to CFS head of investments Al Clark.
“We’re thinking about doing an out-of-cycle SAA review only because there’s so much going on, particularly in the US, where the new administration appears committed to disrupting the existing world order,” he tells Professional Planner.
For CFS, which manages over $70 billion across a range of diversified funds and separately managed accounts (SMAs), SAA is the most sensible and efficient way to achieve a portfolio’s long-term objectives, however, a profound change in the environment may require the group to refresh its market assumptions and reevaluate risk.
“We’ll look back on those first few weeks in April and think, there are decades when nothing happens and there are weeks when decades happen,” Clark says, referencing a quote loosely attributed to Vladimir Lenin.
“We’re dealing with a [US] administration that has such a haphazard and chaotic approach to policy setting so it’s hard to know how much confidence to place on some decisions.
“It’s just hard to know how committed they are to any given task so you’re trying not to overreact and jump at shadows.”
That said, Clark believes there is evidence of a “meaningful shift” to the way the world is being ordered, pointing to America’s increasingly solitary and insular stance under President Donald Trump.
“If you look at the US administration’s first 100 days, it’s very much been engineered towards reverse globalisation and that’s a pretty profound change,” he says.
While CFS ponders a mid-cycle SAA review, it has recently made three material DAA calls.
On the global fixed income front, the group’s SMA portfolios have a “duration tilt” favouring Australian bonds over US treasuries. CFS has also increased its hedging ratios, preferring the Australian dollar over the US dollar and, for equities, portfolios are tilting towards value over growth.
“We just don’t believe that US treasuries offer the same protection that they used to, and they represent the most meaningful part of the global fixed income benchmark,” Clark says.
“US treasuries may not be as defensive going forward, which has caused us to think that Australian duration is a better defensive play.”
Similarly, CFS is reducing its exposure to the US dollar.
“If the epicenter of a market dislocation is the US, then the US dollar won’t be as defensive as it has been in the past, and so we’ve increased our exposure to the Australian dollar,” Clark says.
When it comes to equities, Clark likens value stocks to a “bird in the hand” as they typically have higher payout ratios and dividends, and are currently cheaper than growth.
“Value tends to be not as high beta and tends not to rally as strongly and you give up some capital growth, but we believe that dividends and higher payout ratios are more valuable at the moment,” he says.
“In an environment where policy is moving around significantly, and inflation is moving around significantly, and you’re not sure the direction that things are going to go, relying on capital growth is not as predictable as it has been in the past.”
Geographical diversification
With the high level of uncertainty in the market, the importance of diversification comes to the fore.
Across CFS’ range of diversified funds and SMA portfolios, the group is pursuing greater geographical diversification, particularly in global equities, where the US represents around 65 per cent of the MSCI All Country World Index.
The US equity market is also dominated by growth sectors and stocks.
Despite the stellar performance of US equities in recent years, there are several reasons why diversifying away from US equities makes sense, according to Clark.
“Because there is so much risk around policy and it does feel like there’s a new deglobalisation framework, spreading your bets makes sense, even if you don’t have a clear view on where things are headed,” he says.
He adds even if there’s more risk in the system, it makes sense to try and neutralise some of that risk.
“Even if you do have a strong view on where you think this policy stuff is going and your view is that the US will move to reindustrialise and bring manufacturing back onshore, then many US companies face headwinds, given they have been big beneficiaries of globalization,” Clark says.
“We don’t believe the new world order will be as beneficial for the big US platform companies, which is another reason it makes sense to [geographically] diversify.”
While CFS’ recent DAA calls have tilted portfolios towards non-US stocks and bonds, investors still have meaningful exposure to the world’s largest national economy.
“The construct of the [MSCI World] index means that the majority of what you get is still going to US [equities] so if you believe in the US exceptionalism story, you’ll still be participating to a large degree in that story,” Clark says.
