Getting the asset mix right is as crucial as ever during the current pandemic-induced investment cycle. Clifford Fram explores how investment professionals are approaching different asset classes and sectors and finds ETFs have matured into powerful asset-allocation tools.  

If there’s one thing financial planners are inclined to agree on, it’s that asset allocation is a more critical component of portfolio performance than market timing or stock picking. It’s a notion backed by academic research, with contemporary studies continuing to cite the 1986 claim by Brinson, Hood and Beebower that strategic asset allocation decisions can explain 93.6 per cent of performance variation.  

For financial planner James McFall CFP® , Managing Director of Yield Financial Planning, the key to balancing risk and return is to satisfy the sleep test. “A big part of getting asset allocation right is about managing it in the context of the client’s risk profile because that’s going to factor into their comfort level,“ he says. “Some of our clients have been nervous about COVID and the recession. A large part of the conversation has involved us reassuring them that we have their asset allocation right; that they are positioned in such a way that they don’t need to sell growth assets at the wrong time.“  

Tactical challenges 

Nobody’s saying just yet that the long-term performances of the various asset classes are going to be fundamentally different from their historical trajectories. But there are tactical challenges: negligible returns on cash, a quirky bond market, limited diversification options on the ASX and COVID-19 impacted retail, office and hospitality rentals. At the same time, gold is at a record high. 

“Many financial planners are using tactical asset allocation to take into account market conditions at the present time,“ says Alex Vynokur, the CEO of ETF provider BetaShares.  

“The world has undoubtedly changed very significantly with COVID-19. The synchronised plunge of economies, the corresponding stimulus by global central banks, the ultra-low interest rate environment and very low growth are certainly presenting challenges that need to be taken into account. 

“The need to get asset allocation right in this environment is as important as ever. Each of the elements, whether it’s Australian equities, global equities, fixed income or alternatives, for example, presents its own opportunities, even in the difficult and uncertain environment.“ 

A vital enabler 

Alex sees ETFs as a vital enabler for financial planners to serve the asset allocation needs of their clients. 

“Being able to use simple, transparent and cost-effective building blocks such as ETFs to implement asset allocation is a very compelling proposition. That’s one of the reasons why the ETF industry around the globe has grown so significantly, and it’s why the proportion of financial planners in Australia who use ETFs has grown significantly over the past decade and will continue growing.“ 

(Source: Stockspot, ASX, March 2020) 

Financial planner Sally Huynh CFP®, Private Client Adviser at Shadforth Financial Group has coined the acronym CFC (COVID-19 Financial Crisis). “Whether we call it CFC or GFC, it’s another event on the share market. In any major economic event, asset allocation has to be right,“ she says. “It’s not about treatment. It’s about prevention. Setting the right expectation and getting everything right from the beginning will achieve the right outcome for clients. But it is absolutely dependent on the client’s goals and objectives and their specific circumstances.”  

“Clients definitely need us more during this time. This is the time to stay closer to them and truly understand their thinking, which will help us provide the right information to support them.” she adds.  “We remind and reassure them that, although this health pandemic is rare, the volatility we’re seeing in equities is not uncommon. It actually forms part of the normal investment journey.” 

It pays to work extra hard to make sure clients are fully informed and don’t make wrong decisions, she says.  

James focuses on reminding clients that that markets go up and down, and not in a straight line either. “We encourage them to be true to their investment strategy. We show them that they are in a position to ride out the bumps and just carry on enjoying their life.“ 

Selling opportunity 

That said, James believes the market has bounced back sufficiently to offer clients some flexibility.   

“It comes back to the client’s individual circumstances and to re-evaluating their risk profile. One thing we are saying to clients is that there is an opportunity for us to reflect on whether we are invested appropriately for their comfort level.“ 

If the market were in the depths of its COVID-19 fall, he would not be changing risk profiles. “Volatile markets like these can highlight to some clients that they are invested in a higher risk profile than they are comfortable with, but once markets are in free fall, it is usually too late to change. Right now, there’s an opportunity.“ 

People nearing retirement and those already relying on their investments for income are a particular challenge in the current environment. 

“We’ve had to re-evaluate how we approach the income-generation needs of clients,“ says James. “Typically, we don’t invest just for yield. We look to meet income requirements from a combination of the income being generated and capital. It’s about structuring assets to be invested in the best way they can be for the climate to maximise the longevity of funds overall.“  

But James is concerned about the almost perfect storm of challenges across bonds, commercial property, Australian equities and global equities. 

“Traditional bonds are not the investments they were as recently as a year ago,“ he says. “And a recession is always a bad thing for commercial property. Businesses downsize or close, and the need for space reduces. Layer COVID-19 on top of that and you’ve got a severely changed landscape. Until COVID-19, valuations were very high because the yield was being chased. But now there is uncertainty there.“ 

Sally is less pessimistic about property and sees growth opportunities amid the upheaval in some sub-sectors within property.   

“If you look at distribution centres for e-businesses, their demand has increased. There are different sub-sectors within property, and some do behave differently.  Property, like other growth asset classes, has its up and downs, but reducing its allocation when it has already gone through a major decline is probably not a sensible strategy in my view.“ 

Although the Australian economy is in better shape than many international counterparts, James is concerned that lower immigration levels will hinder growth. He is also worried about the impact of the Banking Royal Commission on lending policy.  

At the same time, central banks are pumping liquidity into Australian and international markets, which is both supporting share prices and raising concerns about long-term consequences.  

Going offshore 

For Sally’s clients, the most significant asset allocation change over the past six to 12 months has been increased exposure to overseas equity markets and reduced exposure to the ASX.  

The main drivers have been diversification away from financials and resources and a wish to gain more exposure to other sectors such as international technology, health and utilities.  

“Taking a 10-year view domestic equities don’t appear to offer a good growth outlook, and sector concentration in the ASX could mean higher risks compared with more diversified global markets,“ she says, “Our biggest shift has been more allocation to overseas shares.“   

For overseas investments, 50 per cent of the foreign currency is usually hedged, Sally says. 

“Currency in the long run is a zero-sum game. Our view is that you cannot predict the trend in the short term, so we take the middle ground.“ 

James too favours global shares over Australian and has been talking to clients about what he describes as a two-tier economy. Some companies are failing and flailing; think travel and hospitality. Others are surviving and thriving; think tech and healthcare,  he says. 

James believes ETFs are a powerful way to isolate investment opportunities, an area in which he says active managers have traditionally had an edge.  

Modern ETFs cover almost every investment need. These include traditional local and global index funds, ethical investments, niche sectors, high yield products, derivatives, gold bullion, model portfolios and almost everything in-between.  

“The filters ETFs can apply can give investors a very targeted strategy, much like in the past you relied on managers to provide,“ says James. 

Alex, who founded BetaShares 10 years ago, is proud of the growing sophistication of the ETF industry. 

“We have been working with our clients to improve the positioning of their portfolios. Now more than ever is the time to focus on quality exposures – companies that have low financial leverage, strong balance sheets and good pricing power in the market.“ 

The BetaShares Global Quality Leaders ETF is one example of a fund that helps financial planners tick those boxes, says Alex. “The focus on quality enables the planner to shift asset allocation in a way which positions client portfolios to deal better with the uncertainty of this market environment.“

Alex says some people might describe products like Quality Leaders as smart beta exposure. “It’s not a pure capitalisation-based index. It is an index that is tilted towards quality companies by removing those with high financial leverage, stretched balance sheets and challenged cash flow.“ 

Adding value 

The increasing sophistication of ETFs will challenge active managers and drive the growth of the industry, says Alex. 

“The evolution that we have seen in the way financial planners think about ETFs has been phenomenal and has got many decades to go. ETFs will continue to grow in importance to investment portfolios and will continue to add value.“  

But there is space in the market for both index management and active management to coexist.  

“For us, this is not about active versus passive. It is about the reality of the investment process and the reality of the investment world. In addition to that, there are a number of ETFs that are actively managed. ETFs are not just about passive exposure.“ 

Alex believes ETFs have a place in any portfolio. “The democratisation of investing that ETFs are bringing to the fore has been benefitting financial planners and has been helping their clients. It is not only the fact that ETFs are lower cost than actively managed funds. A fact that is quite often ignored is that, for the most part, portfolio performance is actually improved by combining or replacing active management with index funds. 

“The evidence over one, three, five, ten and twenty years is that three-quarters of active managers tend to underperform their benchmark net of fees.“  

Another factor in ETFs’ favour is the ease of investing, says Alex. 

“Whether you believe in active or passive, ETFs can deliver the investment experience in a much more investor-friendly way.“  

For many people, the tradability of ETFs is preferable to the rigmarole of having to fill in and email complex application forms and proof of identity documents. 

“You can buy and sell an ETF on the stock exchange just like any share, and you can have liquidity like with any share. You don’t have restrictions or lockups. And also you have the convenience of having the certainty of the price at which you buy and sell. The experience of buying and selling ETFs is what the vast majority of investors expect in the 21st century. 

“The investor experience, transparency and confidence of transacting at a known price, whether you are a buyer or a seller, is a very significant advantage of ETFs.“ 

Model portfolios 

James is an advocate for using model portfolios to match asset allocation to clients’ risk tolerance. 

“We follow an investment philosophy of change when change is needed, not change for change’s sake. Therefore, model portfolios give us a level of transparency and confidence in knowing what any one client is holding at any one time. The investments that we hold across those models are the same across the different risk profiles; we just hold them in different weight.“ 

Alex says model portfolios go a long way towards addressing the question of asset allocation. 

“Model portfolios are a very cost-effective and efficient way, for both planners and end investors, to benefit from the advantages of ETFs. They effectively enable a portfolio of ETFs to be produced in accordance with the risk appetite and return expectations investors have. 

“We run several model portfolios which essentially correspond to the risk appetite of the client. We have balanced, conservative, growth and high growth, which offer solutions for both strategic asset allocation and tactical asset allocation. 

“A significant number of planners rely on our asset allocation capability to help them run their practice, and a number of self-directed investors are doing the same.“ 

Alex wants the world to know how significantly ETFs have evolved over the past decade. “What ETFs allow financial planners to do today that was not possible 10 years ago is to play the offence as well as the defence for clients. ETFs can be both a source of growth and capital preservation in a portfolio.“