Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 360

Why asset allocations shifted due to COVID-19

Is asset allocation more important than stock selection? We certainly believe so, and the turbulence of markets in recent times has highlighted the need for a well-diversified portfolio with downside protection.

This is the goal of our multi-asset strategy. Every six months we pore over a raft of economic data, in order to review and reset our core asset allocation. The latest review, completed in April 2020, captured one of the most dramatic periods in recent economic history.

Here’s what we made of it.

Raging bull meets ferocious bear

In our December 2019 review, the question on everybody’s minds was: how long would this bull run last? Now, the question is: how long will this downturn last?

The conversation has flipped 180 degrees in a matter of months.

In our latest review, we tracked every market crash (a fall of 20% or more) since 1929, in terms of how long it took the United States’ key stock market index, the S&P 500, to recover to the same level it had reached immediately before the crash.

While the Great Depression recovery blew out to 266 months, it took as little as three months for other crashes to make up lost ground. Excluding the Depression, however, the average recovery period was 27 months.

Figure 1: Market falls and recoveries since 1929

That means, if this is an ‘average’ crash, then it’s likely that a recovery will take two years or more. But averages can be misleading. At this stage, we simply don’t know the true scale of this downturn.

Our team took a somewhat sober view of the outlook, and incorporated a filter for highly-turbulent regimes in the recent asset allocation review.

This prompted us to make a significant cut to our equities exposure: the collective weight to Australian and global equities has gone from 50% to 29% (comprised of 19% global equities and 10% Australian).

The key reason is that we are cautious about the continued knock-on effects from the COVID-19 outbreak. While equity markets may be trying to look through into a more optimistic future, we think it could be premature.

Government support for fixed income: a gamechanger

A key difference between this and other downturns of the last 100 years is the unprecedented fiscal and monetary stimulus. Australia’s fiscal stimulus is among the largest in the developed world, at 6.9% of GDP (in line with the UK and US, both at 6.9% - according to the International Monetary Fund (IMF) as at 8 April 2020). This has been adjusted from earlier higher estimates due to the $60 billion lower stimulus from JobKeeper.

Governments around the world have pumped money into the economy to try to stave off economic disaster. However, these initiatives will have an expiration date which may - or may not - align with the length of the downturn.


Register here to receive the Firstlinks weekly newsletter for free

With this support in mind, a notable change to our portfolio is the increased exposure to bonds and credit. We increased Australian Government Bonds from 21% to 33% of the portfolio, investment-grade credit from 12% to 20%, while global bonds went from zero allocation to 8% and high-yield credit from zero to 5%.

Figure 2: CFS Multi-Asset Real Return Fund Neutral Asset Allocation (NAA) as at April 2020

We made this decision after taking a view on where we think the global economy is moving, and the likely long-term values for inflation, risk free rates, long-term bond yields and earnings growth. We then tilt the asset allocation based on this outlook.

Our team likes investment grade and high-yield credit at the moment, as we believe it delivers a lower risk portfolio at the aggregate level, especially with strong central bank support. The US Federal Reserve and the European Central Bank have indicated that they will not only be purchasing government bonds and investment grade credit, but for the first time, quality high-yield bonds too.

This is a game-changer for fixed income, particularly in a portfolio context, and it’s one reason why we are reducing risk away from higher volatility equity allocations.

Although government bonds were occasionally caught up in the recent sell-off, alongside riskier assets like equities, we saw the traditional relationship between the two asset classes play out as we hoped: government bond exposures provided diversification to equity exposures during the increased volatility in March.

While liquidity was temporarily scarce, central bank initiatives to inject capital back into the economy subsequently eased anxieties. Given the need to manage risk in the portfolio, our allocation to Australian government bonds has increased significantly, but remains concentrated in shorter maturities.

Managing risk over time

We don’t rely solely on the six-monthly neutral asset allocation (NAA) to construct our portfolio. We also have the benefit of dynamic asset allocation (DAA) which is reviewed weekly and allows us to make investment changes based on shorter-term market dynamics.

While individual investors would find it difficult to manage these two styles of asset allocation, the combination has allowed us to deliver additional returns and reduce portfolio risk, at the same time as meeting our real return objective. Having that flexibility built into our approach is helpful in times like these.

Even if you lack the firepower of a team of professional analysts, there are still lessons to be taken from our multi-asset strategy. In particular, the observation that macro events and economics have a significant impact on market and portfolio risk. As such, it can be appropriate to make asset allocation changes that reflect the current environment as well as the economic outlook.

 

Kej Somaia is Co-Head of Multi-Asset Solutions at First Sentier Investors (Australia), a sponsor of Firstlinks. This material contains general information only. It is not intended to provide you with financial product advice and does not take into account your objectives, financial situation or needs.

For more articles and papers from First Sentier Investors, please click here.

 

RELATED ARTICLES

SMSFs and COVID: the biggest trends in 5 charts

Too much, too fast: four ways we are investing now

How much bigger can the virus bubble get?

banner

Most viewed in recent weeks

Welcome to Firstlinks Edition 433 with weekend update

There’s this story about a group of US Air Force generals in World War II who try to figure out ways to protect fighter bombers (and their crew) by examining the location of bullet holes on returning planes. Mapping the location of these holes, the generals quickly come to the conclusion that the areas with the most holes should be prioritised for additional armour.

  • 11 November 2021

Why has Australia slipped down the global super ranks?

Australia appears to be slipping from the pantheon of global superstar pension systems, with a recent report placing us sixth. A review of an earlier report, which had Australia in bronze position, points to some reasons why, and what might need to happen to regain our former glory.

Welcome to Firstlinks Edition 431 with weekend update

House prices have risen at the fastest pace for 33 years, but what actually happened in 1988, and why is 2021 different? Here's a clue: the stockmarket crashed 50% between September and November 1987. Looking ahead, where did house prices head in the following years, 1989 to 1991?

  • 28 October 2021

How to help people with retirement spending decisions

Super funds will soon be required to offer retirement income strategies for members in decumulation. With uncertain returns, uncertain timelines, and different goals, it's possibly “the hardest, nastiest problem in finance".

Tips when taking large withdrawals from super

You want to take a lump sum from your super, but what's the best way? Should it come from you or your spouse, or the pension or accumulation account. There is a welcome flexibility to select the best outcome.

“Trust your instinct” Hamish Douglass in conversation with Sir Frank Lowy AC

Sir Frank shares his story, including his journey from war-torn Europe, identifying opportunities, key character traits necessary for business success, and the importance of remaining paranoid yet optimistic.

Latest Updates

Investment strategies

20 punches: my personal investments are not a forecast

I prefer not to make market forecasts but I need to take personal investment decisions. I'm expecting a stockmarket fall in 2022 as central banks tighten policies but the mainstays in my portfolio will not be sold.

Retirement

The good news about retirement income

A lower starting withdrawal rate doesn’t always mean living on less. The latest research on sustainable withdrawals offers flexibility for retirees to improve the chances of not running out of funds prematurely.

Shares

Three small companies expected to deliver big returns

Small caps might require more work than large cap stocks but they are often worth it. After all, all large companies were small once, and there can be clear benefits of investing in and backing management early.

5 new trends driving the future of biotech companies

The biotech industry has seen an explosion of new techniques which will lead to innovative areas of growth in the use of cells and genes as medicine. Money for funding life sciences and biotech pharma has soared.

Gold

Gold and inflation: what does history tell us?

Multiple factors have seen gold fall in 2021, despite the rise in inflation. But given gold has performed strongly across longer periods of higher inflation, gold may benefit under the current inflation outlook.

  • 8 December 2021
Retirement

Solutions to unite the three pillars of retirement funding

Retirement solutions uniting the three pillars of retirement funding - the age pension, mandatory super and voluntary savings - are essential. Global experts discuss solutions that might work for Australia.

Investment strategies

New capital rules an effective vaccine for thriving banks

With stronger capital positions, improved brand equity and the potential to benefit from a robust post-pandemic recovery, the global banking sector is presenting significant opportunities for investors.

Sponsors

Alliances

© 2021 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.