Market Thinking Model Portfolios use the principles of behavioral finance within a systematic risk management framework to deliver a dynamic asset allocation process for Absolute Return products. We do not use derivatives, seeking instead to reduce downside risk via the ability to allocate to cash when we see risk as too elevated. The track records shown are based on the published NAVs of large and liquid ETFs used to track the various underlying indices.

Current Thinking – Overview from the Models

As well as offering a ‘different’ way to invest in Global Equities, the Model Portfolios help us gain insight into some of the underlying dynamics of Global Equity Markets by avoiding the country and sector focused traditional benchmarks with their heavy market cap weighted skew. At the end of last year, as concerns about rising discount rates started to hit longer duration assets, this combined with illiquidity issues to hit small and mid cap tech stocks in particular. The models captured these trends and were steadily reducing exposure to the thematic basket such that it has essentially been in cash and gold from the start of the year. By contrast the Global Factors stayed exposed for longer, albeit with a meaningful tilt to Value and have only just moved to all cash due to the Ukraine crisis – in particular due to the concerns over financials rather than cyclicals in general.

Now, we find the risk signals easing slightly for some of the Thematic basket, specifically for Cyber Security and Clean Energy, suggesting the potential risk reward is improving, largely because the distressed selling from three months ago may now be passed. As such we are increasing our exposure in accordance with our process, much as we did in March/April 2020. The Global Equity Factors meanwhile remain all in cash on a “too late to sell, too early to buy basis”.

Global Equity Portfolios

Global Equity Factors

The Global Equity Factor portfolio uses the Five common factors that Academic studies show as offering excess return over the long run; Momentum, Value, Size, Quality and minimum Volatility. Taking the Global Index for each and a liquid ETF that tracks each index, we allocate towards each of the indices (plus cash) using our investment framework.

The Chart shows the Dynamic Asset Allocation between Factors over the last two years, highlighting the shift to all cash in late January/early February of 2020 and the moves back in from April/May onward. Similar ‘white bars’ during December and January reflected increased exposure to cash, with February seeing the last remaining factor – Value – switch to cash.

Chart 1. Factors moved fully to Cash last month

The Models are meant as Absolute Return, but for comparison purposes, we have nevertheless added a standard Global Equity benchmark. The one we are using in the graph is the MSCI All Country Index.

Global Equity Themes

The Global Equity Theme portfolio is another way of taking a diversified portfolio of Global Equites – this time arranged along thematic lines – and dynamically asset allocating between a total of eight thematic ETFs, each tracking a Global Thematic index. The eight indices are, Robotics and Automation, Digitisation, Cyber Security, Clean Energy, digital health, Emerging Mkt Consumers, Gold and Fintech. Plus, of course, cash.

The Thematic Portfolio has been heavily in cash for most of the year to date, with its only long exposure being Gold. Because most of the themes are reasonably ‘long duration’ and thus quite high bet, during q3/q4 of 2021 we gradually saw their risks levels rising. Starting with EM Consumers ( a lot connected with the China ADR issue), then moving through the mid cap tech names, especially in Digitisation, healthcare innovation and clean energy – the latter, having performed extremely well in 2020, had a disappointing year in 2021 as risks levels remained high and we were accordingly under-represented for most of the year. Overall, by end year most of the risk signals were to be ‘out’ of the Themes and in cash.

Chart 2. Global Thematic Fund skewed to cash and Gold since late 2021 – putting toes back in.

(Note the charts show average weekly exposure to each ETF, the system itself runs daily.)

Interesting, therefore, to see that in early March our risk models gave an indication of timing for increasing exposure to two of the themes – Digital Security and our old friend Clean Energy. This is similar to 2020, when March/April saw some indicators that the distressed selling in certain sectors was over and the worst was ‘in the price’. Accordingly we have started to recommit and slowly increase our exposure in these two areas (from zero). NB, we only added Fintech to the ‘basket’ in late 2021, which is why it is not in the charts, but as of today there has not yet been a positive buy signal.

The Global Benchmark we use here for comparison is the same as for the Global Factor Model, ie, the MSCI All Country world Index. However, given the idea is more about Absolute Return, and to show the return over the benchmark isn’t just due to high beta stocks, another way of demonstrating the ‘value add’ of the Dynamic Asset Allocation process is to choose as a benchmark the simple average of the Themes chosen. Doing this, we can see that the systems behind the Model Portfolio help it to outperform here as well. The two obvious areas of outperformance here are when the portfolio is holding cash – exactly as we would expect it to be.

The idea is to protect the downside, while capturing as much of the upside Beta as possible.

Chart 3. Capture upside Beta and avoid downside.

One way to think of the two different ways in which the DAA process can help invest in Global Equity is that the Factor approach is like a ‘Core’ fund and the Thematic Approach more of a ‘Satellite’ fund. (The notion of Core and Satellite is widespread amongst wealth managers, although their ‘Core’ is usually some form of tracker fund). This also plays into the different ‘messages’ we are receiving from the system; the lower-risk core fund generally has lower and steadier returns as a consequence, but currently the uncertainty levels are such that it has been steadily increasing its cash component all year and is now sat ‘on the sidelines’. Meanwhile, the higher-risk, high beta satellite Thematic portfolio had a very powerful second half of 2020 before tracking largely sideways during 2021. Rising risk in the third quarter of 2021 led to a shift to cash that helped protect the downside from the ‘wash out’ over the last three months and now, despite the broader uncertainty picked up in the Factor Portfolio, the risk/reward is starting to shift again.

Caveat and disclaimer

Please note that the Model Portfolios are about asset allocation, not trading, nor are they intended to generate trading ideas and nor are we offering any investment advice on this blog. It is, as they say, for information and (hopefully) entertainment purposes only. Always consult your advisor.

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