LF Prudential Risk Managed Active & Passive Funds Strategic Asset Allocation Review 2021
The 2021 review continues the theme of evolving portfolios to capture new asset classes, future growth opportunities and sources of more attractive returns from fixed income markets.
Building alignment with underlying PruFund portfolio, be it through adding new managers or new asset class exposures is also important, particularly with the Active range.
As always there are several key considerations when reviewing the long-term positioning of portfolios.
Forward looking view on markets
The main driver for longer-term strategic asset allocation (SAA) decisions is always our long-term views on asset classes as reflected in the T&IO Capital Market Assumptions, updated twice a year by the Long Term Investment Strategy (LTIS) team.
The team assess each major economy and region on an individual basis, principally assessing the growth of the productive capacity for each economy. Inputs to this include both faster and slower moving trends, including population growth, GDP growth, demographics, availability of labour, savings & investment rates and trends in technological progress. ESG is also built into this assessment.
Not only does the assessment of these factors help to build a picture of a country or region across a broad range of economic indicators but it also helps build a level of consistency within expectations across economies.
When setting the SAA, the team also must assess the here and now and understand where asset values sit relative to the forward-looking return expectations?
We have spoken many times about our thoughts on the Asian growth story and the desire to reflect this across portfolios. Increased exposure to the region has been achieved across equities, property and fixed income.
New asset classes and underlying building blocks
Work is always ongoing across T&IO to assess new asset classes that we feel add long-term value to portfolios through offering strong risk adjusted returns, low correlation, higher yields or stable income streams. When a new asset class is agreed by the strategists and signed of by the business it is the role of the T&IO Manager Oversight to find a suitable manager of vehicle to put the money to work.
This work was certainly evident in the 2020 review where several new asset classes, China and African equities and emerging market debt, were added to portfolios.
This year has since a continuation of this theme as the team can leverage of this work and allocate to new asset classes using largely internal funds already employed within PruFunds.
Assessment of costs / Optimising portfolios
Recent changes to PRIIPs regulations on disclosure of costs (primarily within the alternatives holdings) within the funds led to what appeared to be an increase in the total charges for each fund. Whilst the actual costs hadn’t changed it did act as a trigger for the business to re-assess the pricing of each range in what can often be a ‘price sensitive’ market, particularly for passive funds.
The key challenge was to ensure that there was no compromise from an investment perspective such that any changes to portfolios did not undermine the integrity of the investment process.
The decision to add more new asset classes was key as they bring different elements to portfolios, Indian equities and Asian property for example. This meant there was now more latitude to reduce exposure to some of more expensive alternative assets as our modelling confirmed there would be no reduction in the anticipated risk/return outcome from each portfolio.
We anticipate the OCFs will fall to around 25-26bps for Passive funds and 55-56bps for Active funds over the next few months.
Before getting into the detail the high-level changes across all portfolios were - equity increased, fixed income increased, property increased (actives), alternatives and cash reduced.
At a more granular level the main adjustments were;
UK Equity to be increased across Active and Passive portfolios
- Continue to favour a tilt towards the UK, where valuations remain attractive relative to other developed markets
- US, Europe and Asia continue to feature across overseas equities and our long-term preference for Asia remains as the global economic centre of gravity is shifting towards this region.
Indian Equity to be added to Active and Passive portfolios
A small allocation has been added. There are several reasons;
- Is one of the fastest growing economies in recent years since it initiated economic reforms and further opened to global trade, transitioning well into the services sector
- Domestically driven, which provides different economic factors and diversity from other more homogenous parts of Asia
- Share of global GDP has doubled over the last 25 years to 4% in current US dollar terms whilst its MSCI market capitalisation only accounts for about 1% of total
- Demographic outlook and the economy’s structural composition suggests a high growth potential
- India has relatively good market depth in terms of equity market capitalisation, turnover and the number of listed domestic companies
- Equity market volatility remains higher relative to developed market peers but has come down over the past decade
- Exposure initially through the iShares MSCI India UCITS ETF USD
Chinese Equity to be increased across Active portfolios
- Separate China equity sleeve allows flexibility and ability to increased exposure across all portfolios
- Aim to increase risk profile of active range
- Will continue to be an equal split between Value Partners Group / M&G Investments
African Equity increased
- Aim to increase risk profile of active range
- Underlying exposure still through futures
Emerging Markets Debt increased across Active and Passive portfolios
- A mixture of local and hard currency, government and corporate debt continue to offer further diversification.
- Emerging market bonds offer the potential for portfolios to benefit from higher real returns than developed markets
- Active management still important in navigating the risks associated with the asset class
Asian Fixed Income to be increased in Active portfolios and added to the Passive portfolios
- The region continues to benefit from a broadening and deepening market
- Economies at different stages of the monetary cycle provide diversification and opportunities for active managers to capture higher yields
- Another active fixed income manager in the passive range
- Positions to be implemented over the course of November and December
Developed market fixed income reduced across Active and Passive portfolios
- Reduction in global high yield
- Small reduction in US investment grade
- Government bond yields in developed markets remain close to historic lows.
- Central bank initiatives and credit support schemes have kept corporate credit spreads low
- Absolute returns in developed markets are relatively unattractive
The increase in Asia and Emerging Markets Debt provides higher yields and exposure to a diversified set of monetary and fiscal regimes, with substantially higher room for monetary stimulus.
European and Asian property added to the Active portfolios
- New overall allocation will be 70% UK, 12% European and 18% Asian property when fully transitioned
- In line with the direction of travel in PruFunds which have benefited from wider geographical coverage
- Increased exposure to the greater return potential of some of the Asian markets
- Allocation to the M&G European Property and M&G Asian Property funds may take 6-12 months – large well diversified institutional funds used in PruFunds
- Exposures initially through iShares European Property REIT and iShares Asian Property REIT
- Expect to be at new overall regional allocation by end November
Alternatives reduced across Active and Passive portfolios
- As part of the overall review, we concluded that the risk/return characteristics of portfolios can be maintained with reduced OCFs
- Allocation will be fully invested in equities for the Passive funds and split approximately 70% equities, 30% property in the Active funds
- Diversification benefits of new asset classes mean that there is no trade-off in future risk adjusted returns
- Holdings have largely been sold down to new weights as of 1 November.
Cash reduced across Active and Passive portfolios
- Same level as that in the equivalent PruFund Risk Managed funds
- Should also enhance returns as fixed income allocation will be directed towards Asian and Emerging Markets assets
- Cash allocation still sufficient for liquidity management and operational purposes.
Alignment of building blocks
This review has also coincided with several underlying fund changes as we continue to leverage vehicles used in PruFunds to align underlying portfolios, particularly the Active range, and in the most cost-efficient manner.
The work on creating new vehicles to use across Prudential multi asset portfolios has been ongoing for some time. The tables below summarise where these, and other funds used in PruFunds, are employed in the Active and Passive ranges.
(*) ACS: Vehicle providing similar exposure / mandate design as PruFund
Fixed Income & Property
* *Currently a capital queue for access to fund and subject to regulatory approval. Interim exposure via iShares Regional REITS.
New portfolio shapes
Below are the updated SAA tables for the LF Prudential Risk Managed Active 3 and LF Prudential Risk Managed Passive 3 funds and their respective changes relative to the 2020 review.
ARTICLE by Adrian Gaspar
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