Dugald Higgins
The investment environment of the past 30 years is irrevocably changing, with adherence to the traditional 60:40 portfolio allocation breaking down, and the rise of ESG investing impacting portfolio construction, according to Zenith Investment Partners and Heuristic Investment Systems.
Heuristic Investment Systems Head of Asset Allocation Damien Hennessy said the traditional portfolio allocation of 60 per cent to growth and 40 per cent defensive assets is no longer viewed by investors as the most logical investment ratio.
“Bonds might still offer diversification in a deflationary scenario but with starting point yields so low and some emergence of inflation risk, we cannot be entirely confident that bonds will provide the buffer they have in the past. Investors have to consider other lines of defence for their portfolios.
“A portfolio’s strategic asset allocation is one of the key drivers of the variability of returns across funds while manager selection is also critically important. Dynamic asset allocation provides a further source of return enhancement or risk mitigation for a portfolio. An investor ideally wants all areas contributing to better portfolio outcomes.
“In addition to current elevated valuations, macro factors such as interest rates and inflationary pressures are increasingly having an impact on the strategic and tactical execution of asset allocation strategies.
“For investors wary of valuations, embedded risk factors and sector skews inherent to benchmarks, active investment management will be the key to managing risk over the long term.
“Investors are becoming much more discerning in their investment decision-making and in the past 12 months alone, we have noticed a significant rise in interest from investors in strategies that incorporate sustainability goals.”
However, Zenith Investment Partners’ head of real assets and listed strategies and Chair of Zenith’s Responsible Investment Committee, Dugald Higgins, said despite the increased awareness of ESG, there remains a lack of nuanced understanding of its implementation in portfolio construction.
“Certainly, the rate of signalling ESG adherence from managers is increasing, as is the quality and sophistication of ESG-focused investment strategies. However, there is still a lot of confusion from some advisers about how to effectively integrate ESG considerations into portfolios.
“The ‘large cap bias in ESG’ – where large companies often score higher in ESG due to greater resourcing capabilities – is also a prevalent issue when examining fund managers. There is a rapidly widening gap in intensiveness of ESG integration that will likely become more pronounced for those fund managers who lack the resources to critically assess these issues,” he said.
Higgins also cites the growth in the ETF market as an influence driving the changes in portfolio construction.
“While growth in ETFs continues to provide valuable tools for those who like the liquidity, transparency and simplicity of the ETF structure, increasing granularity in the marketplace is rapidly moving these products away from their genesis as a source of simple, broad market exposure at minimal cost.
“We believe approximately 90 per cent of index-based ETFs are considered niche constructs – using methodologies in focused strategies across specific geographies, sectors, market capitalisation sleeves and risk factors,” Higgins said.
“These typically exhibit greater returns dispersion and higher drawdown characteristics. While they can provide useful exposures which can complement a portfolio, care needs to be taken to ensure users have a detailed understanding of how these impact portfolio outcomes.”