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Diversified growth
strategies and
their role in Australian
Superannuation Funds
Contents
Executive summary
4
Introduction
5
Diversified growth strategies: a brief history
6
Key features of diversified growth strategies
7
Benefits of diversified growth strategies for Australian institutional investors
10
To hedge or not to hedge?
18
Potential uses of diversified growth strategies for Australian Superannuation Funds
21
The Investec Diversified Growth Strategy
25
Conclusion
31
Appendix
32
Authors
Michael Spinks,
Co-Head of Multi-Asset, and Portfolio Manager of
Investec Diversified Growth Fund (Australian)
Atul Shinh,
Multi-Asset Investment Specialist
The views expressed in this document are those of the authors and reflective of the wider Investec Multi-Asset team. Investec Asset Management
is a multi-specialist house and therefore the views expressed may or may not be held by our other specialist investment teams.
Executive summary
○○Diversified growth strategies are multi-asset programmes that flexibly
invest in a range of traditional and non-traditional return sources to seek
a defined outcome.
We believe Australian
investors cannot rely on
domestic assets alone
○○They were originally designed for UK Defined Benefit pension schemes
in the mid-2000s but are now utilised by all types of institutional investor
on an increasingly global basis.
○○These strategies can vary in approach, but typical features include a
total return objective, a broad opportunity set, flexible asset allocation,
enhanced diversification and the use of numerous implementation
methods.
○○We believe that the breadth of opportunity set, investment flexibility and
active approach to currency management of diversified growth
strategies should be particularly appealing to Australian Superannuation
Funds, as in our view they cannot rely on domestic assets alone to meet
their performance objectives.
○○The role that diversified growth strategies can play for Australian
investors will vary depending on the nature of the investor, but their
potential as a liquid alternative solution, given their diversifying
properties, stands out.
○○Our historical modelling suggests that there would have been a clear
portfolio benefit to including a diversified growth strategy in a typical
Australian Superannuation portfolio. The modelled realised return was
higher, the overall portfolio volatility lower and the result therefore was
improved risk-adjusted returns. It should also be noted that the benefit
was enhanced when substituting from Australian equities rather than
International equities. For example, according to our modelling, a 15%
allocation to a diversified growth strategy funded out of Australian
equities would have added 1.5% per annum to the overall return of a
typical Superannuation Fund, whilst lowering the volatility (see page 23
for methodology).
○○The Investec Diversified Growth Fund (Australian) was launched in May
2015, following the launch of the sterling denominated Investec
Diversified Growth Strategy in 2008. Investec Asset Management has
been successfully managing a broad range of multi-asset strategies,
including those with total return profiles, for over 20 years.
4
Diversified growth strategies and their role in Australian Superannuation Funds
Our historical
modelling shows the
potential benefits to
Superannuation
Funds of diversified growth
strategies
Introduction
Multi-asset programmes that flexibly invest in a range of traditional and nontraditional return sources, focusing on both risk management as well as
investment return generation have attracted significant interest from institutional
investors in recent years, creating a new market segment known as diversified
growth strategies.
Although originally designed for UK Defined Benefit (DB) pension schemes, other
investors (principally Defined Contribution schemes) from the UK and globally
have recognised the role that diversified growth strategies can play in helping to
meet their respective objectives. These strategies have attracted the growing
interest of a number of Australian Superannuation Funds, which is of no surprise
given their objectives are often aligned with those of diversified growth strategies.
This paper provides some background behind diversified growth strategies,
describes the important characteristics that define these strategies and explains
their potential application to Australian Superannuation schemes. We conclude by
offering a brief overview of the Investec Diversified Growth Strategy.
Diversified growth strategies and their role in Australian Superannuation Funds
5
Diversified growth strategies: a brief
history
The concept of diversified growth strategies started in the UK following the
‘dotcom’ crash in equity markets in the early 2000s. Some DB schemes,
chastened by this poor equity experience and dissatisfied by the performance of
traditional multi-asset balanced strategies over this period, started looking at
alternative methods to help generate more sustained growth in returns. Thus, the
concept of reducing the reliance on equities to generate growth in returns, by
flexibly investing in a better diversified set of growth drivers was born.
Additionally, regulatory pressure and the requirement to reflect pension deficits on
the balance sheet of companies created a much greater focus on the volatility of
returns realised and the risk that was being taken to generate returns. At the
same time, new methods to access a much wider opportunity-set for investors
were opening up and, following years where a ‘buy-and-hold’ approach was richly
rewarded, the bear market in the early 2000s highlighted the more negative
consequences of this lack of asset allocation decision making.
The global financial crisis (GFC), a few years later, provided the first major test to
the validity of the broad diversified growth model. Already at this stage, there was
a degree of variation in the approaches employed as participants in the space
showed a tendency to anchor their diversified growth approach on some of the
multi-asset methods they historically relied upon. This variation of approach
resulted in a considerable range of outcomes over the course of the GFC, with
some strategies demonstrating strong downside protection characteristics,
whereas others performed little better than equities.
Subsequently, these strategies have not only had to contend with generally strong
returns from developed market equities, bonds and credit, but also poor returns
from strategies typically classified as ‘diversifiers’, notably commodities and
emerging market debt. While volatility has generally trended lower as central
banks have maintained their interventionist monetary policies, there have been
some significant market episodes to challenge these multi-asset approaches and
their ability to meet both the return and risk objectives post the GFC. Therefore,
the investment environment and deviation in asset class performance has
heightened attention on the approaches employed by diversified growth
managers, specifically around portfolio construction, idea generation and
implementation precision.
Diversified growth strategies have been one of the most popular choices for new
allocations from institutional investors in recent years, which in itself has attracted
a swathe of new market participants. It is estimated that the size of this
marketplace was c. AUD 230 billion as of March 20151.
Source: Camradata, using GBP/AUD exchange range of 1.95
1
6
Diversified growth strategies and their role in Australian Superannuation Funds
Key features of diversified growth
strategies
To date the diversified growth space has been characterised by significant
variation in the underlying approaches employed. However, there are areas of
commonality that we can point to in describing a ‘typical’ diversified growth
investment model, which we detail below.
‘Outcome-based’ objectives
The objective of achieving growth while limiting volatility is typically expressed
through a ‘total return’ target (normally a return premium over inflation or the rate
of cash), as opposed to a return target relative to a market based benchmark. A
volatility target or risk objective is also present.
This outcome-based approach ties in with the objectives of many Superannuation
funds, which normally look for returns from their assets in excess of inflation.
Further, as schemes have been using diversified growth strategies as a diversifier
or as a growth asset substitute, there is an expectation that their performance
and the path of their performance will deviate from broad market indices.
Breadth of opportunity set
Historically, balanced ‘multi-asset’ strategies tended to be focused on traditional
assets, such as equities and government bonds related to the local domestic
market of the investment manager. Diversified growth strategies, on the other
hand, access a much broader opportunity set, covering both traditional and
alternative sources of return, with a global perspective.
The range of asset exposures that may be included in diversified growth
strategies therefore includes, amongst others, global equities, emerging market
equities, developed market government bonds, emerging market bonds, inflationlinked bonds, high yield bonds, investment grade bonds, property, private equity,
commodities, volatility strategies, hedge funds, infrastructure, reinsurance and
active currency positions.
Diversified growth
strategies access a
broad, global
opportunity set,
covering traditional and
alternative sources of return
By expanding the number of investment opportunities available and the type of
returns that can be accessed, diversified growth strategies have more return
‘levers’ to exploit over the course of the market cycle, and opportunities to
manage risk. This should increase their ability to achieve more consistent returns,
and reduce the reliance on returns from individual markets.
Enhanced diversification
As its name would suggest, the diversification of exposures is a key component of
the diversified growth concept. Diversification, if applied correctly, can help
achieve the desired outcome of these strategies by achieving long-term growth,
but with an improved certainty of outcomes than would otherwise be the case by
solely focusing on assets such as equities. Clearly, following from above, a broad
opportunity set can be an important starting point in achieving diversification.
Diversified growth strategies and their role in Australian Superannuation Funds
7
However, although ‘diversification’ is not new to multi-asset strategies, the
experience of the GFC, where many ‘diversified’ portfolios did not perform as
expected, has contributed to a better understanding of what it takes to achieve
more effective diversification. As such, just owning lots of different assets is not
always enough; it is important to understand the fundamental drivers of assets,
how assets are likely to behave and the role they can play. The design of
diversified growth strategies enables them to better achieve superior
diversification compared to many traditional multi-asset strategies and this
crucially links back to the focus on risk management in these strategies.
Intrinsic to many
diversified growth
strategies is a focus on risk
management.
Flexible asset allocation
The ability and willingness to allocate between and within different asset classes
is an important characteristic of diversified growth strategies. Although the
frequency and magnitude of these decisions will vary from approach to approach,
the flexibility to both take advantage of market opportunities and to protect
against market risks is beneficial to the strategies in achieving their long-term
objectives.
In contrast, the managers of traditional multi-asset strategies have either been
constrained in their ability to deviate beyond a narrow range of allocations, or
have been unwilling to express high conviction asset allocation positions.
Evolved implementation techniques
Diversified growth strategies use a number of methods to implement investment
views. As well as using internally managed programmes and direct investments,
diversified growth managers are increasingly using other methods, such as
relative value positions (i.e. taking a relative view of one asset or market compared
to a related asset or market) or bespoke baskets (i.e. hand picking a number of
holdings to reflect the required investment idea) to express views.
By largely removing market directionality from the position, relative value holdings
can provide uncorrelated exposures to a strategy. The use of these positions can
thereby further expand the opportunity set available to the strategy, as they
provide a potential additional source of return. Other long / short overlays that
exhibit clearer directionality can also play a useful role in isolating a market risk
factor, for example the small-cap equity premium. Bespoke baskets, on the other
hand, can ensure there is greater precision around the view being expressed.
These types of exposure become more important in environments where positive
market beta effects are less prevalent.
Risk management/downside protection
Diversified growth strategies are ever more focused on the evaluation of what
could go wrong and truly understanding all the risks affecting the portfolio. In
practice, this means the consideration of risk implications as part of the
investment decision process, regular independent monitoring of the risks facing
the portfolio, evaluating the impact on the portfolio of different potential market
stresses and implementing positions that are specifically designed to provide the
portfolio with a degree of downside protection in adverse environments.
8
Diversified growth strategies and their role in Australian Superannuation Funds
Diversified growth
strategies use a number
of methods to implement
views.
A strong risk management discipline, combined with effective portfolio
diversification as described above, can improve the ‘worst case’ outcome for
investors and reduce uncertainty about achieving the performance objectives.
Base currency focused
One of the key advantages of a diversified growth approach is that it is structured
with the base currency liabilities (such as domestic inflation or cash related) of
investors in mind. In other words, these strategies provide access to a global
opportunity set, but from the starting point of a domestic investor and their
needs. Clearly there are potential benefits from accessing assets denominated in
an overseas currency, from either a risk reduction or return enhancement
perspective, but the decision of whether to hedge this exposure or not should be
an active decision relative to the starting point of the investors’ base currency.
Diversified growth strategies and their role in Australian Superannuation Funds
9
Benefits of diversified growth strategies for
Australian institutional investors
Having detailed the typical characteristics of diversified growth strategies, we will
now explore the potential benefits that these strategies provide for Australian
institutional investors. Specifically, we will explore how these strategies should be
well placed to meet real growth return objectives while providing investors with
increased certainty about achieving this outcome.
Firstly, we will explain why Australian institutional investors should not rely on
domestic assets alone to provide certainty around achieving a real return (in this
instance, equivalent to domestic Inflation +5% i.e. a ‘real’ return of 5% on an
annualised basis). We will then discuss why a broader opportunity set, in terms of
both geographic and asset exposures, provides the return potential to achieve the
return objective. We then describe the role that diversification can play in helping
to reduce the range of possible outcomes of a portfolio. Finally, we conclude by
explaining the important role that an active approach to currency management
plays for an Australian investor.
How reliable are domestic Australian assets for achieving
the required return?
With the proportion invested in domestic Australian assets by Superannuation
funds typically ranging from 40-50%2, it is clear that despite the ongoing move to
internationalise Australian Superannuation fund portfolios, there is still a
significant reliance on domestic assets to achieve the required returns for these
schemes.
An analysis of the historical returns achieved from these assets, however, shows
that an investor could have achieved better returns by taking a more global
approach in the past. To illustrate this, Figure 1 shows the annualised real returns
of Australian equities, Australian bonds and Australian cash, over a number of
discrete 10 year periods from 1900 to 2010, including the best and worst
returning 10 year periods. We have compared these returns to the performance
target of a 5% annualised real return.
Figure 1: Australian asset classes through the decades (1900-2014)
Bonds
Cash
Target
Source: Credit Suisse Global Investment Returns Sourcebook 2015
Source: Rainmaker Information - December 2014
2
10
Diversified growth strategies and their role in Australian Superannuation Funds
Average
Average of
10 year periods
Equities
Worst 10 years
-10%
Best 10 years
-5%
2000-2010
-5%
1990-2000
0%
1980-1990
0%
1970-1980
5%
1960-1970
5%
1950-1960
10%
1940-1950
10%
1930-1940
15%
1920-1930
15%
1910-1920
20%
1900-1910
20%
-10%
There is still a significant
reliance by
Superannuation Funds on
domestic assets.
Over the time period of 1900-2014, although Australian equities exceeded the
performance objective, it was achieved with a high volatility, indicating a
significant variability of return and therefore a high degree of unreliability in
achieving a consistent return profile. Australian bonds and cash, on the other
hand, both significantly underperformed the objective over this extended period,
demonstrating they have not been effective in generating the required return.
We do recognise, however, that the impact of the franking tax credit on dividends
results in enhanced domestic equity returns for many Australian investors, thereby
increasing their attraction relative to global markets. However, we believe the
dynamics of the domestic equity market (with a small market relative to the global
equity opportunity set and a reliance on financial sector companies) should
encourage investors to look beyond this potential franking benefit when assessing
the attractiveness of the market.
Our forward-looking view on the prospects of these assets does not change our
opinion about the reliability of Australian assets to generate the return target
either. We believe that most Australian Superannuation Funds are over exposed to
domestic assets and should target a broader global opportunity set to give them
a better chance of meeting their performance objectives. The next section
provides further justification for our views.
Breadth of opportunity set
Diversified growth strategies access a broad opportunity set, covering both
traditional and alternative sources of return, and with a global geographical
perspective. By expanding the number of investment opportunities available and
the type of returns that can be accessed, diversified growth strategies have more
return ‘levers’ to exploit over the course of the market cycle. This should increase
the ability to achieve more consistent returns, and reduce the reliance on
individual market returns.
Diversified growth
strategies have many return
‘levers’ to exploit through a
market cycle.
We will evidence the benefit that accessing a broader opportunity set can provide
by assessing the historical returns of a wide range of assets and geographies in
comparison to domestic Australian assets. In this analysis, for simplicity, we have
focused on the local market returns of the respective assets in question. We will
show later that the decision of whether to hedge non-Australian dollar exposure
makes a significant difference to the returns that investors receive.
Figure 2 overleaf shows the calendar year returns of a number of different markets
from the past 10 years. Within each calendar year, we have ranked the markets
from the highest returning to the lowest returning, showing the percentage return
achieved for all assets.
Diversified growth strategies and their role in Australian Superannuation Funds
11
Figure 2: Australian assets versus global assets over the past decade
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
Japan equity
(45.2%)
Emerging
Market
equity
(32.1%)
Emerging
Market
equity
(39.4%)
Global
government
bonds
(39.7%)
Emerging
Market
equity
(78.5%)
Emerging
Market
equity
(18.9%)
Australia
government
bonds
(14.2%)
Japan equity
(20.9%)
Japan equity
(54.4%)
Global
Corporate
bonds
(12.8%)
Emerging
Market
equity
(34.0%)
Europe
equity
(18.5%)
EM Debt
Local (18.1%)
Australia
government
bonds
(20.2%)
Australia
equity
(30.8%)
Commodities
(16.7%)
Australia
Corporate
bonds
(10.0%)
Emerging
Market equity
(18.2%)
US equity
(29.6%)
US equity
(11.4%)
Europe
equity
(24.6%)
Australia
equity
(18.3%)
Australia
equity
(12.2%)
Global
Corporate
bonds
(15.5%)
EM Debt
Hard (29.8%)
EM Debt
Local (15.7%)
EM Debt
Hard (7.3%)
Global HY
(17.8%)
Global HY
(25.3%)
Australia
government
bonds
(11.1%)
UK equity
(20.8%)
EM Debt
Local (15.2%)
Commodities
(11.1%)
Australia
Corporate
bonds
(11.6%)
UK equity
(27.3%)
US equity
(12.8%)
Global
government
bonds (6.8%)
EM Debt
Hard (17.4%)
Europe
equity
(19.2%)
Japan equity
(10.3%)
Australia
equity
(20.3%)
UK equity
(14.4%)
Hedge Funds
(10.3%)
EM Debt
Local (-5.2%)
Global HY
(25.6%)
UK equity
(12.6%)
Global
Corporate
bonds
(4.5%)
EM Debt
Local (16.8%)
UK equity
(18.7%)
Global
government
bonds (9.5%)
Commodities
(17.5%)
US equity
(13.6%)
UK equity
(7.4%)
Global HY
(-9.2%)
Europe
equity
(24.6%)
EM Debt
Hard (12.2%)
Global HY
(2.6%)
Europe
equity
(15.8%)
Global
Corporate
bonds
(16.2%)
Global HY
(9.2%)
EM Debt
Hard (10.2%)
Hedge Funds
(10.4%)
EM Debt
Hard (6.2%)
EM Debt
Hard (-12.0%)
US equity
(23.5%)
Australia
Corporate
bonds
(7.5%)
US equity
(0.0%)
Australia
equity
(14.9%)
Australia
equity
(15.7%)
Australia
Corporate
bonds
(8.6%)
Global HY
(8.4%)
EM Debt
Hard (9.9%)
Australia
government
bonds (3.7%)
Hedge Funds
(-21.4%)
EM Debt
Local (22.0%)
Europe
equity (5.9%)
EM Debt
Local (-1.8%)
US equity
(13.4%)
Global
government
bonds
(11.0%)
EM Debt
Hard (7.4%)
Hedge Funds
(7.5%)
Global HY
(5.6%)
US equity
(3.5%)
UK equity
(-28.3%)
Commodities
(18.7%)
Hedge Funds
(5.7%)
UK equity
(-2.2%)
Australia
Corporate
bonds
(11.5%)
Hedge Funds
(9.0%)
Europe
equity (4.2%)
EM Debt
Local (6.3%)
Australia
Corporate
bonds
Europe
equity (3.0%)
Commodities
(-36.6%)
Hedge Funds
(11.5%)
Australia
government
bonds (5.2%)
Hedge Funds
(-5.7%)
UK equity
(10.0%)
Australia
Corporate
bonds
(4.8%)
Hedge Funds
(3.4%)
(3.7%)
Australia
Corporate
bonds
(6.1%)
Japan equity
(3.0%)
Australia
Corporate
bonds
(2.5%)
US equity
(-38.5%)
Japan equity
(7.6%)
Japan equity
(1.0%)
Commodities
(-13.4%)
Global
Corporate
bonds
(9.7%)
Australia
government
bonds (0.1%)
Australia
equity (1.1%)
Australia
government
bonds (5.7%)
Australia
government
bonds (2.1%)
Global
government
bonds
(-0.6%)
Australia
equity
(-39.9%)
Australia
Corporate
bonds
(6.3%)
Global HY
(-0.1%)
Australia
equity
(-14.9%)
Australia
government
bonds (5.5%)
Emerging
Market
equity
(-2.6%)
UK equity
(0.7%)
Global
Corporate
bonds
(3.6%)
Global
Corporate
bonds
(-0.3%)
Global
Corporate
bonds
(-3.7%)
Japan equity
(-40.6%)
Australia
government
bonds
(-2.7%)
Australia
equity
(-3.5%)
Europe
equity
(-14.9%)
Hedge Funds
(4.8%)
EM Debt
Hard (-5.3%)
Emerging
Market
equity
(-2.2%)
US equity
(3.0%)
Global
Government
bonds (-1.1%)
Global HY
(-7.5%)
Europe
equity
(-44.4%)
Global
Corporate
bonds
(-7.6%)
Global
Corporate
bonds
(-7.0%)
Japan equity
(-17.0%)
Global
Government
bonds (0.5%)
EM Debt
Local (-9.0%)
EM Debt
Local (-5.7%)
Global
Government
bonds
(-0.1%)
Commodities
(-2.7%)
Japan equity
(-11.1%)
Emerging
Market
equity
(-53.3%)
Global
Government
bonds
(-20.7%)
Global
Government
bonds (-7.3%)
Emerging
Market
equity
(-18.4%)
Commodities
(-1.1%)
Commodities
(-9.6%)
Commodities
(-17.0%)
Source: Bloomberg (list of markets in Appendix)
12
Diversified growth strategies and their role in Australian Superannuation Funds
It can be seen that over this period there has been significant dispersion between
the highest and lowest returning assets and that the ranking of Australian assets
compared to other assets within each calendar year has varied significantly. This
table therefore evidences the opportunity cost from just focusing on Australian
assets, given the returns that have been available from other markets.
We should not only focus on the return that would have been missed from a
narrow focus on Australian assets. Investing in a broader set of assets would have
also reduced the variability experienced by an investor compared to just focusing
on domestic assets, which in turn would have likely led to a lower volatility profile.
Figure 2 also helps us to highlight the potential benefits from taking an active and
high conviction approach to dynamic asset allocation across different assets. For
example, an allocation to Japanese equities on a currency hedged basis in 2012
would have had very beneficial results for an overall portfolio through to the end of
2014. Conversely, avoiding commodities over this period would have proved
beneficial too. Finally, the presence of negative returning markets in certain
periods shows that investors should not just think in the one dimension of which
assets will go up. Paying attention to which assets might go down as well adds
another potential stream of returns, either by taking direct ‘short’ positions or
through the construction of the aforementioned relative value positions.
Paying attention to which
assets might go down is
important and adds another
potential return
source.
Benefits of diversification
The correlation between two assets can be a useful measure to help determine
the extent of diversification possible, by providing information on how assets have
behaved in different environments historically. For example, assets with a
tendency of exhibiting a negative correlation to equities can play a useful role in
providing protection in the event of significant falls in equity markets. It is
important to note though that correlations vary over time, and assets that may
have behaved in a certain way in the past will not necessarily behave in the same
way in the future.
It is important to note
that correlations vary
over time.
To illustrate this point, we show a series of charts overleaf displaying the historical
correlations between Australian equities and a range of global and domestic
assets as well as the stability of these relationships. Given that our starting point
is the belief that Australian investors should be looking to diversify away from
Australian assets, and equities in particular, it follows that we believe those assets
with either favourable correlations and/or return potential would be useful
additions in constructing a portfolio to meet the return objectives. Further detail
on our methodology relating to Figures 3-8 is set out in the Appendix.
Diversified growth strategies and their role in Australian Superannuation Funds
13
Historical correlations on a
hedged basis
Figure 3: Global and regional equities vs Australian equities (hedged)
60
Figure 3 shows that on a hedged
basis, the main equity markets under
consideration have demonstrated a
fairly high correlation to Australian
equities, with Japanese equities
showing a lower but still noteworthy
level of correlation. The variability of
correlations for these markets are
reasonably low, indicating that these
fairly high correlations have been
persistent over time.
50
EM equities
40
Variability of correlation (%)
US equities
30
Europe equities
UK equities
20
Japan equities
10
-1.0
-0.8
-0.6
-0.4
-0.2
0.0
0.2
0.4
0.6
0.8
1.0
Correlation to Australian equities (%)
Figure 4: Global and regional bonds vs Australian equities (hedged)
60
50
Global GB
40
Variability of correlation (%)
Global Corporate
Global HY
30
Australia GB
20
Australia Corporate
10
-1.0
-0.8
-0.6
-0.4
-0.2
0.0
0.2
0.4
0.6
0.8
1.0
Correlation to Australian equities (%)
Figure 5: ‘Alternatives’ vs Australian equities (hedged)
60
50
Hedge funds
40
Variability of correlation (%)
Commodities
EM LC
30
EM HC
20
10
-1.0
-0.8
-0.6
-0.4
-0.2
0.0
0.2
0.4
0.6
Correlation to Australian equities (%)
Source: Bloomberg, see appendix for details
14
Diversified growth strategies and their role in Australian Superannuation Funds
0.8
1.0
Figure 4 shows that on a hedged
basis, Australian bond markets have
provided the potential for strong
diversification benefits, with domestic
government bonds and domestic
corporate bonds exhibiting
uncorrelated returns to Australian
equities. It should be noted that
Australian government bonds in
particular have exhibited a high
variability of correlation though,
indicating that they could not have
always been relied upon to provide
diversified returns to equities. Global
bond markets have exhibited mixed
behaviours, with global government
bonds providing an uncorrelated
source of returns to Australian equities,
but with investment grade, and high
yield in particular demonstrating a
reasonable degree of correlation with
low correlation variability. This
suggests their diversification properties
were muted.
Figure 5 shows that on a hedged
basis, various ‘alternatives’ have only
provided a limited degree of
diversification over time, with
reasonably low variability of correlation.
Emerging market debt, in particular,
has exhibited a modest level of
correlation to Australian equities.
Historical correlations on
an unhedged basis
Figure 6: Global and regional equities vs Australian equities (unhedged)
60
50
EM equities
40
Variability of correlation (%)
US equities
Europe equities
30
UK equities
20
Japan equities
10
-1.0
-0.8
-0.6
-0.4
-0.2
0.0
0.2
0.4
0.6
0.8
1.0
Correlation to Australian equities (%)
Figure 7 shows that on an unhedged
basis, global bonds have exhibited
strong diversification benefits, with
global government bonds and
investment grade bonds showing
material negative correlations, and high
yield showing negligible correlation.
The correlation variability of global
government bonds and investment
grade bonds has been fairly low,
indicating their historical diversification
effectiveness has been reliable.
Figure 7: Global and regional bonds vs Australian equities (unhedged)
60
50
Global GB
40
Variability of correlation (%)
Global Corporate
Global HY
30
Australia GB
20
Australia Corporate
10
-1.0
-0.8
-0.6
-0.4
-0.2
0.0
0.2
0.4
0.6
0.8
1.0
0.6
0.8
1.0
Correlation to Australian equities (%)
Figure 8: ‘Alternatives’ vs Australian equities (unhedged)
60
50
Variability of correlation (%)
Hedge funds
Figure 6 shows that on an unhedged
basis, there has been a range in the
correlations between the main equity
markets under consideration and
Australian equities, with some markets
such as Japan demonstrating a fairly
low correlation. On the whole, these
markets have exhibited greater
variability of correlation on an
unhedged basis compared to on a
hedged basis, but still at a fairly low
level of variability overall.
40
Finally, Figure 8 shows that on an
unhedged basis, various ‘alternatives’
have provided a good degree of
diversification over time, with their
returns more or less uncorrelated with
Australian equities over time. The
variability of correlations of emerging
market debt and hedge funds
suggests, however, this diversification
benefit has not been stable over time.
Commodities
30
EM LC
EM HC
20
10
-1.0
-0.8
-0.6
-0.4
-0.2
0.0
0.2
0.4
Correlation to Australian equities (%)
Source: Bloomberg, see appendix for details
Diversified growth strategies and their role in Australian Superannuation Funds
15
A few conclusions can be made based on the above correlation and return
analysis:
• On the whole, most equity markets have historically only provided limited
diversification benefits to Australian equities, but they can provide significant
additional return potential as illustrated in Figure 2. As a result, a broader set of
equity market exposures can be beneficial to the overall risk-adjusted returns of
a portfolio.
• Australian bonds have historically provided a powerful diversification benefit to
Australian equities, although the relationship has proved to be variable. This
suggests that they could not always be relied upon for diversification and that a
flexible allocation approach to investing in these assets would be sensible.
A broader set of equity
market exposures can
be beneficial to the
overall risk-adjusted returns
of a portfolio
• Global government bonds have also historically provided a strong diversification
benefit to Australian equities, although again with a reasonable degree of
variability. This supports the argument for a flexible allocation approach to
investing in these assets.
• Global high yield bonds, on a hedged basis, have exhibited poor diversification
characteristics with Australian equities, although have provided significant
additional return over certain periods (as illustrated in Figure 2).
• The usefulness in terms of diversification benefits and the return generation
potential of ‘alternative’ investments have varied considerably depending on the
asset in question. This suggests that although certain ‘alternative’ assets can
play an important role in both the generation of returns and in the control of
volatility, this sub-set is not homogenous in its behaviour.
• It is evident that most of the asset correlations vary significantly depending on
whether the returns are calculated on a hedged or unhedged basis. This
suggests that the treatment of foreign currency exposures for different assets
has a significant impact on the role they can play in a portfolio and the
subsequent level of diversification that can be achieved.
• This result highlights the risky nature of the Australian dollar as a base currency
and the potential diversification benefits of other currencies, most notably the
US dollar. Managing the appropriate level of base currency exposure and
carefully selecting other exposures is therefore a critical decision.
To further emphasise the last couple of points, in Figures 9 and 10 we have
restated and consolidated the same charts to show the clusters of correlations for
equities, bonds and alternatives on both a hedged and an unhedged basis.
16
Diversified growth strategies and their role in Australian Superannuation Funds
Treatment of foreign
currency exposures for
different assets has a
significant impact on
the role they can play in a
portfolio
Figure 9: Correlation clusters for equities, bonds, ‘alternatives’ on a hedged
basis
60
50
Variability of correlation (%)
Equity
40
Bonds
30
Alternatives
20
10
-1.0
-0.8
-0.6
-0.4
-0.2
0.0
0.2
0.4
0.6
0.8
1.0
Correlation to Australian equities (%)
Figure 10: Correlation clusters for equities, bonds, ‘alternatives’ on an
unhedged basis
60
50
Variability of correlation (%)
Equity
40
Bonds
30
Alternatives
20
10
-1.0
-0.8
-0.6
-0.4
-0.2
Correlation to Australian equities (%)
0.0
0.2
0.4
0.6
0.8
1.0
Source: Bloomberg, see Appendix for details
It can clearly be seen that the general effect of leaving foreign currency exposures
unhedged has been to significantly reduce the correlations of assets to Australian
equities. Does this mean we should be advocating a fully unhedged approach for
a multi-asset fund that is targeting a return in excess of CPI? We explore the
importance of active currency management in the next section.
Diversified growth strategies and their role in Australian Superannuation Funds
17
To hedge or not to hedge?
The decision of whether to hedge foreign currency exposures as an Australianbased investor can make a significant difference to the overall outcome
experienced – it not only affects the return achieved of individual assets but also
impacts their interaction with other assets.
Given the return objectives of diversified growth strategies are typically structured
with the specific domestic liabilities of the investor in mind (e.g. Australian CPI
+5% for Australian investors), it therefore follows that the starting point for the
strategy’s currency exposure should also be domestically skewed. In other words,
the base position for a diversified growth strategy should involve the full hedging
of overseas assets back into the base currency. Every currency exposure
deviation away from that starting point is then a deliberate and conscious
decision based on the views about different currencies, the roles they can play in
a portfolio and how they interact with one another.
As we explain later on the paper in the section about the Investec Diversified
Growth Strategy, different currencies exhibit different characteristics and can play
varying roles in a portfolio, e.g. as a return generator, as a risk reducer, or as an
uncorrelated stream of returns. However, in order to understand the roles that
different currencies can play in a diversified growth portfolio, it is first of all
important to understand the characteristics of the base currency in question, as
this will influence the manner in which other currencies interact relative to it.
We would categorise the Australian dollar as a ‘Growth’ currency given that its
performance and behaviour is linked to global drivers of economic growth. Figure
11 shows the rolling 36 month correlations between the S&P 500 (in USD terms)
and the return from Australian dollar vs US dollar. Figure 11 supports our view that
the currency exhibits growth properties and is particularly sensitive to market
crises (as its correlation to equities has spiked over these periods, i.e. the
Australian dollar has tended to depreciate when equity markets have been falling).
Figure 11: Rolling 36 month correlation of S&P 500 (USD) to AUD/USD
1
0.8
0.6
0.4
0.2
0
1992
1995
1998
2001
2004
2007
2010
-0.2
-0.4
Source: Bloomberg, 31 March 2015
18
Diversified growth strategies and their role in Australian Superannuation Funds
2013
Different currencies
exhibit different
characteristics and can play
varying roles in a
portfolio.
As well as looking at historical relationships to help determine the expected
behaviour of the Australian dollar, we also try to understand why the relationships
exist and therefore whether they are likely to persist. For the Australian dollar, we
believe the role of China as a key export partner for Australia’s commodity
products, notably iron ore, has significantly increased the relationship between
the currency and global risk assets.
This Growth characteristic of the Australian dollar goes some way to explaining
why the correlation of unhedged returns has been lower than for hedged returns.
Foreign assets gain value from an Australian investors’ perspective when the
Australian dollar depreciates (and vice versa), which has recently typically
occurred in global market sell-offs, meaning that the currency effect acts
somewhat as a counterbalance to the negative returns that would otherwise be
achieved.
Understanding the
‘Growth’
characteristic of the
Australian dollar is very
important.
However, it is not as simple as just concluding that all foreign asset exposures
should be left unhedged. When calculating the impact from the hedging of foreign
asset exposures, the interest rate differentials between the foreign country and
the domestic country needs to be factored in. Australian investors have benefited,
particularly in the last few years, from the interest rate differential being in their
favour (i.e. the interest rate in Australia has been higher than in other developed
countries), which has meant, for example, that a fully hedged exposure has
generated a positive carry. Figure 12 shows just this – it decomposes the return
that an Australian investor would have received from fully hedging an allocation to
the S&P 500 index into the component relating to the underlying index return in
USD and the component relating to the hedging benefit.
Figure 12: US equities (AUD hedged) return decomposed: US equities local
return and interest rate differential benefit
40
40
30
30
20
20
10
10
0
0
-10
-10
-20
-20
-30
-30
-40
-40
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
US Equities (USD) - LHS
Interest rate differential benefit - LHS
-50
%
%
-50
US Equities (AUD Hedged) - RHS
Source: Bloomberg, 31 December 2014
Diversified growth strategies and their role in Australian Superannuation Funds
19
So should an investor be focused on the potential return uplift resulting from
hedging overseas exposure or should they be focused on the correlation and
portfolio construction benefits from leaving overseas exposure unhedged?
The answer, of course, is not straightforward, and lies somewhere in between.
There will be times when it is right to hedge overseas exposure for some assets
but not for others. Conversely, there will be other times when it is right to leave
more overseas exposure unhedged (e.g. in the event of market turmoil). This
trade-off between increased carry versus volatility reduction is often a central
theme in our investment debates around hedging strategies. From a diversified
growth strategy perspective there is the further consideration of taking all
positions relative to the base currency objective, as described earlier.
The answer on whether to
hedge or not hedge is
not straightforward.
Figure 13 demonstrates both of these points. It shows the difference between the
monthly returns from a fully hedged allocation to the S&P 500 index and the
monthly returns from an unhedged allocation to the S&P 500 index, from an
Australian investors’ perspective. A positive figure indicates that the fully-hedged
allocation has outperformed the unhedged allocation over a particular month, and
vice versa. We have overlaid the chart with the cross rate between the Australian
dollar and the US dollar. It can be seen that in periods of Australian dollar
strength, it has been advantageous to fully hedge the overseas exposure.
Conversely, in periods of Australian dollar weakness, it has been advantageous to
leave overseas US dollar exposure unhedged.
Figure 13: Monthly differential between S&P 500 AUD hedged and unhedged,
and AUD/USD rate
1.2
0.15%
1.1
0.1%
1
0.05%
0.9
0%
0.8
-0.05%
0.7
-0.1%
0.6
Difference (RHS)
Mar 15
Feb 14
Feb 13
Feb 12
Feb 11
Feb 10
Feb 09
Feb 08
-0.2%
Feb 07
0.4
Feb 06
-0.15%
Feb 05
0.5
AUDUSD (LHS)
Source: Bloomberg, 31 March 2015
The primary conclusion is that understanding and managing currency exposure is
a vital component to integrate into the investment process, playing both a risk
management and return enhancement role.
20
Diversified growth strategies and their role in Australian Superannuation Funds
Understanding and
managing currency
exposure is a vital
component to integrate
into the investment process
Potential uses for of diversified growth
strategies for Australian
Superannuation Funds
Having outlined the typical features of diversified growth strategies and the
benefits they can provide above, it is clear that they can play an important role for
Australian institutional investors. This is particularly the case given that equities
are the key drivers of returns for most Australian Superannuation funds, large and
small, DC or DB. This reliance on equities comes with a cost of short term
volatility that can create uncertainty about returns that investors will achieve at
any given point or over a particular time horizon. For DB schemes that are
looking to meet their liabilities, this lack of certainty creates issues, particularly if
they are in the path of de-risking assets. For DC schemes, volatility can unsettle
members such that they lose faith in the concept of pension savings prompting a
switch to lower returning ‘safer’ assets.
Below, we outline four potential uses that diversified growth strategies can play
and assess the applicability of these uses for different types of institutional
investors. We finish with an exploration of what the impact of including a
diversified growth strategy in a ‘typical’ Australian Superannuation Fund could
have been.
Diversified growth
strategies can play a
variety of different roles for
different types of
institutional investor.
1. One-stop shop
As outlined earlier, the majority of diversified growth approaches offer investors
exposure to a combination of traditional and alternative return sources, with the
aim of achieving a stable and positive total return over time. Therefore in many
respects, the multi-asset teams managing these strategies and the trustee boards
managing their pension funds are not too different in what they are trying to do.
Diversified growth strategies, in effect, offer investors a ‘one-stop shop’ of
exposures. Most pension funds would be unlikely to rely solely on one diversified
growth strategy to achieve their goals, although experience in the UK has shown
that DC schemes have often used one or two diversified growth strategies as the
main component in their default range.
2. An option within the Superfunds structure
With Australian Superannuation Funds increasingly looking at providing different
risk/return options to their members, we think that diversified growth strategies
can play an important role in this provision of options. For example, diversified
growth strategies can provide an option of a return of inflation +5% with half the
level of volatility of equities, in isolation, or can be combined with other assets
such as equities and bonds to provide additional options, with the risk/return
objectives depending on the exact mix of assets.
Diversified growth strategies and their role in Australian Superannuation Funds
21
3. Liquid alternatives solution
We demonstrated above that a global opportunity set and an active approach to
currency management can result in a set of return streams that are very different
to domestic Australian returns, particularly to domestic equities. The risk
management disciplines of diversified growth strategies, including explicit
downside protection mechanisms, can also help to differentiate the return pattern
of these strategies. Given the majority of diversified growth strategies are available
to investors on a daily dealing basis, they can be regarded by investors as
providing many of the characteristics of a liquid alternatives solution by offering an
effective diversifier away from equities, while still providing the required return
potential.
4. Outsourced CIO model
As we explained above, most diversified growth approaches are flexible in their
overall asset allocation, being able to react to changing market dynamics more
quickly and nimbly than most pension funds, which are typically restricted by their
governance arrangements. This asset allocation flexibility is important as it allows
the strategy not only to benefit from significant return opportunities, but also to
protect against significant market threats. As well as benefiting directly from this
asset allocation expertise through an allocation to a diversified growth strategy,
pension funds can also utilise these asset allocation insights to help them in the
management of the overall pension fund portfolio too. This concept of idea
sharing between the investment manager and the pension fund to influence the
management of the pension fund portfolio is known as an ‘outsourced
CIO model’.
Different roles for different investors
The roles that diversified growth strategies can play will depend on the nature of
the investor. For example, a sophisticated pension fund with strong levels of
governance will probably have less need for a diversified growth strategy as a
diversifier in their portfolio, but may benefit from the outsourced CIO role it can
play. The diagram below attempts to summarise the different roles diversified
growth strategies can play for different investors.
Greater relevance for schemes with strong governance
One-stop
shop
Option within
Superfund
structure
Liquid
alternatives
solution
Outsourced
CIO model
Greater relevance for schemes with limited governance
22
Diversified growth strategies and their role in Australian Superannuation Funds
The roles that diversified
growth strategies can
play will depend on the
nature of the investor.
Modelling the benefit of diversified growth inclusion
To illustrate the potential benefits from including an allocation to a diversified
growth strategy, and to highlight its role as a diversifier away from equities in
particular, we have conducted some analysis that models the impact on
introducing a diversified growth strategy into a ‘typical’ portfolio. We have chosen
an initial strategic asset allocation based on what we consider to be broadly
representative for an Australian Superannuation scheme, as follows:
Figure 14: A representative Australian Superannuation scheme portfolio
Australian cash
10.0%
Australian equities
25.0%
International developed market equities (ex Australia)
22.5%
Emerging market equities
5.0%
Australian bonds
10.0%
Global bonds
7.5%
Australian property
10.0%
Infrastructure
10.0%
Source: Investec Asset Management
We have assumed a hypothetical portfolio, (which we refer to below as the
‘typical’ portfolio) that rebalances on an annual basis, with a hedge ratio of 50%
(i.e. foreign assets are 50% hedged back to Australian dollar). To represent the
diversified growth strategy, we have used the track record of the Investec
Diversified Growth Strategy. Given this track record is sterling based, we have
calculated returns hedged back to Australian dollar. Further details around our
methodology, including the assumptions and the proxy indices used, can be
found in the Appendix.
Figure 15 shows the impact on the return and volatility of returns for the portfolio,
on an annualised basis from May 2008 (the inception of the track record) to end
March 2015 given different sized allocations to the Investec Diversified Growth
Strategy.
Figure 15: Modelling the impact of introducing a diversified growth fund into a
Superannuation fund
Portfolio
Return
Volatility
Sharpe Ratio
‘Typical’ portfolio
5.2%
9.3%
0.13
5% in DGF (funded from Australian equities)
5.7%
8.9%
0.19
10% in DGF (funded from Australian equities)
6.2%
8.5%
0.26
10% in DGF (funded equally from Australian and
International DM equities)
5.9%
8.6%
0.22
15% in DGF (funded from Australian equities)
6.7%
8.2%
0.33
15% in DGF (funded equally from Australian and
International DM equities)
6.4%
8.2%
0.29
20% in DGF (funded with 15% from Australian
equities and 5% from International DM equities)
6.9%
7.9%
0.37
Source: Bloomberg, 31 March 2015, see Appendix for details
This modelling is not intended as advice or a recommendation but is intended as an illustrative example of the potential benefits an allocation to a
diversified growth strategy could provide if included in a typical Superannuation portfolio.
Diversified growth strategies and their role in Australian Superannuation Funds
23
It can be seen that in this exercise, there has been a clear portfolio benefit to
including a diversified growth strategy (in this example ours) in a broader portfolio
over the period modelled. The modelled realised return is higher, the overall
portfolio volatility is lower and thus results in better risk-adjusted returns. It is
noteworthy that the benefit is enhanced when substituting from Australian equities
rather than International equities.
24
Diversified growth strategies and their role in Australian Superannuation Funds
The Investec Diversified Growth Strategy
We launched an Australian vehicle within our Diversified Growth Strategy in May
2015, but we have been successfully managing multi-asset strategies for over 20
years and have managed the Investec Diversified Growth Strategy (with a sterling
base currency and track record) since 2008.
Objectives and performance
The Investec Diversified Growth Fund (Australian) targets a return of Australian
CPI +5% per annum, gross of fees, with half the level of equity volatility, over
rolling 5 year periods. We judge the success of the Fund by achieving both the
return and risk objectives. The performance of the sterling track record is shown
in Figure 16 for reference.
Figure 16: Illustrative performance of the Investec Diversified Growth Strategy
composite*
14
Annualised (gross) performance in GBP
13.1%
5 year historical
volatility***
11.9%
12
10
9.0%
8
6.4%
Percentage (%)
6
7.0%
7.4%
7.4% 7.5%
5.6%
4.9%
4
2
0
1 year
3 years p.a.
5 years p.a.
Diversified Growth GBP Inflation Plus
Since
inception p.a.**
DGF Equities
UK CPI + 5%
*Source: Investec Asset Management GIPS composite report. This is a representative track
record for our sterling based Diversified Growth Strategy **Composite inception date is 30 April
2008, returns of less than a year are not annualised. ***MSCI World GBP Hedged, over 5 years
Investment team
Michael Spinks and Philip Saunders are the co-portfolio managers, and so
therefore, the ultimate decision makers for the Investec Diversified Growth
Strategy. Michael, who joined Investec Asset Management in 2012, has managed
diversified growth strategies since 2006 and has 19 years of investment
experience. Philip has managed the Investec Diversified Growth Strategy since its
inception in 2008 and has spent the majority of his 34 years of experience
managing multi-asset strategies at Investec Asset Management.
Our investment team
is research-driven and
this is reflected in its
structure.
Managing multi-asset mandates, with the breadth of opportunity set available to
us, requires significant resource, experience and specialist expertise. The
Investec Diversified Growth Strategy therefore benefits from being managed
Diversified growth strategies and their role in Australian Superannuation Funds
25
within the Investec Multi-Asset team. This is an experienced, well-resourced and
well-organised team of over 20 portfolio managers and analysts.
The Multi-Asset team is structured into seven Specialist Research Groups: Macro;
Equity; FX & Rates; Credit; Commodities; Property, Infrastructure & Private Equity;
and Alternative Risk Premia – to ensure the generation of specialist ideas for
potential use amongst our different investment strategies.
Furthermore, the culture of Investec Asset Management means the Multi-Asset
team is able to draw on the specialist equity, fixed income and alternatives
expertise within the firm, both in terms of shared information and resource, as well
as through specific allocations to specialist programmes managed by
these teams.
The structure of the team is set out in the following diagram:
Strategy Leaders
Michael Spinks
Philip Saunders
Specialist Research Groups
Macro
Equities
John
Stopford
Team of 7*
Edmund
Ng
Team of 9
FX & Rates
Russell
Sillbertson
Team of 7
Credit
Commodities
Jeff
Boswell
Team of 5
Property,
Infrastructure and
Private Equity
Michael
Spinks
Team of 4
Alternative Risk
Premia
Max
King
Team of 5
Marc
Abrahams
Team of 4
Investec Investment team
Equities
Fixed Income
Alternatives
Global Investment Infrastructure Support
Dealing
ESG
Risk & Performance
Implementation
As at April 2015. * Includes Mike Hugman, Investec Emerging Market Fixed Income team. Team members may sit in more than one research group
26
Diversified growth strategies and their role in Australian Superannuation Funds
Investment approach
There are three key tenets of our investment approach:
1. We build the portfolio by focusing on underlying asset behaviours and
relationships rather than relying on asset class labels
Market convention suggests that ‘bonds’ should behave differently to ‘equities’
and ‘alternatives’ should behave differently to both ‘bond’ and ‘equities’. However,
we believe this convention is overly simplistic, inaccurate and dangerous. There
are certain assets tagged as a ‘bond’ that actually behave more like ‘equity’. We
demonstrated this above with our historic analysis of high yield bonds, which in
our view should be thought of as equities ‘in disguise’. In respect of ‘alternatives’,
we believe the phrase provides no clues about the behaviour of these assets, and
the choice of which assets are covered by this term is subjective and changeable.
We, therefore, believe it is important to look beyond the labels of asset classes
and instead focus on the underlying behaviours of asset classes when
determining their role in a portfolio. As a result, it is our view that all investments
exhibit either Growth, Defensive or Uncorrelated characteristics.
Growth assets react positively to increasing real economic growth, corporate
earnings, cashflow and risk appetite. Defensive assets react positively to declining
expectations of growth, and provide a safe haven in market crises. Uncorrelated
assets have a variable relationship with growth and risk appetite, with
performance generally unrelated to real economic and corporate earnings growth.
We believe a blend of these characteristics results in superior diversification and
therefore more consistent outcomes.
Growth
• Equities
• High yield debt
• Emerging market debt
and currency
• FX carry
• Commodities
• Property
• Private equity
defensive
• Government bonds
• Index linked bonds
• Investment Grade
bonds
• Volatility strategies
• Shorting growth
uncorrelated
• Infrastucture
• Insurance
• Commodity trading
• Event strategies
• Relative value
Diversified growth strategies and their role in Australian Superannuation Funds
27
2. We use a bottom-up approach based on considering a broad
opportunity set
Our active management approach invests in a broad opportunity set of Growth,
Defensive and Uncorrelated investments. We believe the ability to access this
broad opportunity set allows us to find the most attractive investment
opportunities over the course of the business cycle. Given the different and
changing behaviours of assets, a broad opportunity set provides us with various
choices over time as to which assets to select, and importantly which asset
not to select.
The investment opportunity set is not constrained solely to what assets you can
own – the use of other investment techniques, such as expressing a negative view
about an investment or expressing a relative value view, expands further the
opportunity set available to investors. These techniques can change the
underlying behaviours of assets and so provide other potential investment
opportunities.
By adopting a global approach across a broad opportunity set, the characteristics
can be adjusted through active currency management, adapting exposure with
the base currency in mind. As shown above, particularly when managing from a
risky currency base (as is the case for a sterling or Australian dollar-based
investor), the decision on overseas currency selection is critical to adding returns
and managing risk.
3. We appraise these opportunities using a consistent framework that
focuses on what we call their Compelling Forces (Fundamentals, Valuation
and Market Price Behaviour)
We believe that markets are driven by Fundamentals, Valuations and Market Price
Behaviour:
○○ Fundamentals – are the fundamental drivers improving?
○○ Valuation – is the asset attractively valued?
○○ Market Price Behaviour – are investors buying it or likely to start?
In our view, the best opportunities score well on all three metrics. We believe that
good portfolio construction should exploit a broad range of these opportunities,
balancing their quality against their contributions to risk.
‘Compelling Forces’ framework
28
Diversified growth strategies and their role in Australian Superannuation Funds
Portfolio and positioning
Figures 17 and 18 show the model portfolio positioning of the Investec Diversified
Growth Fund (Australian), as well as the illustrative currency positioning of
the portfolio. We also show the historical positioning of the sterling Investec
Diversified Growth Strategy since inception in Figure 19.
Figure 17: Model portfolio positioning of Diversified Growth Fund (Australian)
Growth
Japanese equity
14.8%
US equity
8.2%
UK equity
6.3%
European equity
4.5%
Other Asia equity
4.6%
China/Hong Kong equity
EM equity
0.7%
0.1%
Property
5.7%
Emerging markets debt
Private equity
2.0%
0.2%
Defensive
Government bonds
17.6%
Cash
16.1%
Short dated government bonds
7.0%
Investment trade
2.5%
Volatility trading
1.7%
Put options -2.3%
Uncorrelated
Infrastructure
5.1%
Global macro
2.8%
Precious metals
-5%
2.3%
0%
5%
10%
15%
20%
Figure 18: Model currency positioning of Diversified Growth Fund (Australian)
AUD
76.0%
USD
19.0%
IDR
6.0%
INR
6.0%
JPY
3.0%
(Other developed)
2.0%
EUR
- 1.0%
TRY
- 1.0%
ZAR
- 1.0%
ILS - 2.0%
NZD - 2.0%
KRW - 2.0%
SGD - 3.0%
-10.0%
0.0%
10.0% 20.0% 30.0% 40.0% 50.0% 60.0% 70.0% 80.0%
Source: Investec Asset Management as at 30 April 2015
Diversified growth strategies and their role in Australian Superannuation Funds
29
Figure 19: Historical positioning of the sterling Diversified Growth Strategy,
since its inception
80%
- % of Fund AUM
60%
Range of allocations
70%
40%
50%
30%
20%
10%
0%
Growth
Defensive
Uncorrelated
*Historical positions of a GBP sterling denominated portfolio, historic range since May 2008. Current
position (diamond): 31 March 2015
30
Diversified growth strategies and their role in Australian Superannuation Funds
Conclusion
There are a few key conclusions to highlight:
• A ‘diversified growth’ multi-asset portfolio can bring global breadth to a
Superannuation scheme while paying attention to local liabilities. These
approaches can balance risk and return in equal measure to build a robust
portfolio that should smooth the path of returns over time.
• We emphasise the importance of a broad opportunity set as well as, in these
times of rising correlations across asset classes, the need to take a bottom-up
approach to uncover opportunities.
• Asset class labels can also offer the allure of diversification without actually
offering significantly different underlying economic drivers, so a focus on
behaviours rather than labels is paramount.
• Our historical modelling suggests that there would have been a clear portfolio
benefit to including a diversified growth strategy in a typical Australian
Superannuation portfolio. The modelled realised return was higher, the overall
portfolio volatility lower and the result therefore was improved risk-adjusted
returns. It should also be noted that the benefit was enhanced when
substituting from Australian equities rather than International equities.
• Finally, there are many different approaches to diversified growth, providing
Superannuation fund executives with a great deal of choice when selecting the
most appropriate management style for their fund. Also, the role that diversified
growth strategies can play for Australian investors will vary depending on the
nature of the investor, but their potential as a liquid alternative solution, given
their diversifying properties, stands out.
Diversified growth strategies and their role in Australian Superannuation Funds
31
Appendix:
Figure 1 – Australian asset classes through the decades
In order to assess the long-term returns of Australian equities, Australian
government bonds and Australian cash, we have referenced the Credit Suisse
Global Investment Returns Sourcebook 2015, written by Dimson, Marsh and
Staunton. This source provides long-term performance information pertaining to
equities, government bonds and cash, for several markets over the period from
1900 to 2014 inclusive.
Figure 2 – Australian assets versus global assets over the past decade
○○ Australia equity = MSCI Australia index (AUD)
○○ Emerging market equity = MSCI Emerging Markets Total Return Index (USD)
○○ US equity = S&P 500 Index (USD)
○○ UK equity = FTSE 100 Total Teturn Index (GBP)
○○ Europe equity = MSCI Europe ex UK Index (EUR)
○○ Japan equity = TOPIX Total Return Index (JPY)
○○ Australia government bonds = Bank of America Merrill Lynch Australia
Government Bond index (AUD)
○○ Australia corporate bonds = Bank of America Merrill Lynch Australia Corporate
Bond Index (AUD)
○○ Global government bonds = Bank of America Merrill Lynch Global Government
Bond Index (USD)
○○ Global corporate bonds = Bank of America Merrill Lynch Global Corporate
Bond Index (USD)
○○ Global high yield = Bank of America Merrill Lynch High Yield Bond Index (USD)
○○ Hedge funds = HFRI Fund of Funds Composite Index (USD)
○○ Commodities = Bloomberg Commodities Index (USD)
○○ Emerging market debt local currency = JP Morgan GBI-EM Global Diversified
Index (USD)
○○ Emerging market debt hard currency = JP Morgan EMBI Global Diversified
Index (USD)
Figures 3 – 8
For the series of scatter charts that plot the historical correlations of a range of
different assets with Australian equities, where available, we have used monthend Bloomberg index data from 31 December 1989 to 31 March 2015 inclusive.
The indices used for these charts are the same indices we described above in
relation to Figure 2. There are some instances though, for example with emerging
market debt, where the data series started after 31 December 1989. We have
32
Diversified growth strategies and their role in Australian Superannuation Funds
plotted these historic correlations versus the variability of these correlations. The
variability of correlation is calculated by using the standard deviation of the
respective calendar year returns of each asset (i.e. 1990 to 2014 inclusive, where
available). The calculations in those charts that used the hedged returns of
different assets were based off the local market returns of these different assets.
Given that hedged returns are calculated through adjusting the local market
returns of the foreign assets for interest rate differentials, it makes little difference
to the correlations (which are focused on the direction of returns rather than their
magnitude) whether the interest rate differentials are incorporated or not.
Therefore, for simplicity, we used local returns for this purpose.
The calculations in those charts that used the unhedged returns of different assets
were based off the foreign asset returns translated into Australian dollars. As such,
they were subject to the currency fluctuations between their local currency and
the Australian dollar.
Modelling Figure 15
Our choice of the stated strategic asset allocation and the proxy indices used to
represent the different assets was based on our knowledge of the Australian
pensions market as well as from information from various asset allocation surveys.
The indices used in our modelling were as follows:
○○ Australian equities = ASX 200 Index Total Teturn (AUD)
○○ Australian cash = Australian 1 Month Cash Total Return Index (AUD)
○○ International developed market equities (ex Australia) = MSCI World ex Australia
(USD)
○○ Emerging market equities = MSCI Emerging Market Index (USD)
○○ Australian bonds = Bloomberg Australian Bond Treasury 0+ Years Index (AUD)
○○ Global bonds = Bank of America Merrill Lynch Global Government Bond Index
(USD)
○○ Australian property = UBS Global Investors Index (AUD)
○○ Infrastructure = S&P Global Infrastructure Index (USD)
Over the period from May 2008 to March 2015 inclusive, we calculated the
hedged returns and unhedged returns for the indices listed above. When
modelling the returns achieved from different allocations, we assumed a hedging
ratio of 50% (i.e. 50% of foreign asset exposure hedged) for the overall portfolio
excluding any allocation to the Diversified Growth Strategy, and an annual
rebalancing policy (i.e. allocations were brought back to the strategic weighting on
an annual basis). The Sharpe Ratio has been calculated using the return of
Australian cash.
Diversified growth strategies and their role in Australian Superannuation Funds
33
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