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Strategic Resource Allocation or: I learned how to stop thinking and love scattering


For decades, strategic asset allocation has been considered the main driving force of investment portfolio returns. But the old adage that allocation determines 90% of performance is rapidly getting old.

By 2020, we have seen how the investment world is shifting from one side to the other where interest rate cuts lead to beta performance that increases the spread of returns across asset classes, regions and sectors. This dispersion has been widened by retail investors who have greater access to the market through supposedly zero-cost investment platforms.

Going forward, near zero or in an era of rising interest rates, beta will play a secondary role in building performance. Since the beginning of 2020, three developments have propelled the future of investment, pushing it towards more precision-based strategies:

D. Pricing process

Interest rates near zero, a combination of financial and monetary stimulus, and increased access to the market among retail investors have changed the pricing system. Many times in the last one year, with gamestops or AMC theaters, prices seem to have been thrown out the window. Due to excess liquidity and behavioral “big fool” expectations, investors believe they will be able to sell at a higher price quickly. Leverage in the public market has increased: Although retail investors were only trading stocks, thanks to the reduction in the cost of derivative transactions, many are now acting as marginal buyers through options.

Many times over the past year, pension funds, sovereign wealth funds (SWFs), and other institutional investors have worked for the cycle rather than being the last resort buyer during market downturns with long-term horizons. For example, large pension funds removed tail risk hedges just weeks before the beer market opened and had to sell some assets amid amendments to facilitate their sponsor’s unexpected liquidity requirements.

The removal of this “reasonable investor” pricing mechanism makes it more difficult to set expectations for different asset classes. There is uncertainty about the validity of the price. This is further complicated by the greater scattering of valuations in seemingly similar businesses: for example, consider holding a Volkswagen valuation to include “electric vehicle premiums” in March.

As the beta has become more uncertain there are expectations for risk management and interrelationships. This then reduces the usefulness of classical beta-based strategies.

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2. Personal assets

The growing importance of returns on personal assets makes it difficult to determine portfolio risk and returns using classical methods.

Over the past decade, institutional investors have rapidly expanded their investments in the real estate, private equity, personal debt and direct nnding to the irregular and private market. There are several reasons for this, some more legitimate than others: for example, expanding the investment opportunity set and diversifying the income stream. But the appraisal gap between market valueless assets and the perceived risk mitigation benefits rarely seems logical. Especially in classical strategic allocation studies, such biases lead to simple private investments that ignore proper diversification within the asset class.

Why are investors looking at the private market? This is because listed exchanges do not have the opportunity to target investment. The development of potentially disrupted sectors, in particular, is sometimes difficult to capture in the public market through medium and large companies.

Thanks to greater computing power, knowledge delivery, and outsourcing opportunities, improvements in industrial automation, oncology, and behavioral design software have, among other areas, made it much easier to give access to the right intellectuals and enterprise capital.

The potential of these fields will last a long time. But only when their entire technological development becomes heavily investable will they be able to choose between winners and losers when it comes to field lifting. In pharmaceuticals, for example, many of the most profitable innovations of the last few decades have been developed locally in bio-science parks. Say, the top 10 pharmaceutical companies weren’t precise enough to profit from these developments.

Whether it’s anti-viral treatment or gene therapy, investing in companies that are specific এবং and risky উপযুক্ত in areas that are suitable for disruption rewards more than going into the risky range of the public market. Nevertheless, the allocation of strategic resources often determines the limitations. It may be difficult or impossible to select a niche manager with deep relationships in the sector in question. In general, these targeted investment strategies do not fit the top-down oriented investment policy and are therefore discarded. As a result, large institutional investors are leaving the opportunity for small players, such as entrepreneurial family offices, to return.

For investors, the larger set of opportunities should outweigh the potential downturn, even after minimizing excessive positive bias in the investment process. Careful bottom-up oriented portfolio construction strategies need to meet the concentration risks, and reasonable risks and return expectations can be fed into the allocation decisions. Or better yet, public and private equity investments can be combined to build a single portfolio to develop diversification.

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3. Change of regime everywhere

Last year’s developments have accelerated the pace of transformation in the industry. The evolution of a long list of performance drivers is now dynamic and makes it more critical to review risk on a single investment basis.

Long-term trends with policies designed to address the effects of Covid-1’s on the global economy have only exacerbated the impact. Changes in the way people work অফিস office vs. remote, physical vs. digital, and local vs. global বিনিয়োগ affect the short-term concept of investment. What will happen to the office building? How many logistics centers will be required? How valuable is a restaurant franchise chain if it can only do home delivery? In the long run, winners will be distinguished from losers because some industries become more resilient than others.

Governments around the world have responded differently to this crisis, but most have come out of the same toolbox and taken stability and compensation through the issuance of debt. Even when the level of debt is considered to be permanent, the policy needs to be normalized to avoid a much more centrally planned economy than in the pre-Kovid era.

At this point, the spread within the wealth class will increase again. Which regions, sectors and companies have taken long-term effective measures to prevent capital loss if the epidemic-related financial assistance is withdrawn?

Another reason to run the market? More focus on environmental, social and governance (ESG) issues. The government has thought of various “green new contracts” that will fund “green” companies or projects. The central bank, the IMF and the World Bank have received similar attention. From the perspective of collective governance, the direction of legislation is becoming clear, some investments will be better located than others.

The geopolitical situation is another matter. Increased competition, efforts to build a stronger supply chain with more credibility efforts, whether for semiconductors or agricultural production, could increase tensions. The rupture of global relations can create both risks and opportunities. The Asian tiger economies may see their fortunes decline, while the economies of Latin America and India may see their improvement. This growing long-term uncertainty establishes a strong strategic resource allocation process and makes it particularly difficult to hold on to over the next decade.

Changing environments and accelerating change will require a deeper understanding of financial and behavioral dynamics, geopolitics, and underlying investment. Without a more holistic and hands-on approach, investors will unwittingly take the risks of money concentration and leave returns on the table while taking more risks.

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What next?

Creating optimal returns in this new era will require investment regimes that provide detailed investment decisions that are consistent over time. This means a more integrated investment structure and new and different methods of risk assessment.

Maintaining stability will only leave performance.

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All posts are the author’s opinion. As such, they should not be construed as investment advice, or the opinions expressed must not reflect the views of the CFA Institute or the author’s employer.

Photo Credit: © Getty Images / Chaluk


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Rance Gottz, CFA

Rennes Gottz, CFA, has been an institutional allocator for more than a decade. He has extensive experience in portfolio management and investment decision making after developing leadership strategies, selecting managers and implementing mandates. Gottz holds a master’s degree in chemistry, is a CFA charterholder, and has completed the Nanroad Executive Pension Program. He can reach r emailgoetz-email.com via email.



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