Tactical asset allocation in calendar 2013 in the context of asset class performances

Given the ever-changing nature of global markets, Elston Portfolios has a policy of operating a flexible approach to asset allocation (i.e. tactical asset allocation). This allows the investment team to allocate a greater proportion of client money to the asset classes / sectors expected to provide the best risk adjusted returns, typically on a 6 – 12 month view.

For all of last year our major tactical positions across client accounts with diversified portfolios included:

• being overweight both Australian and International equity;
• within International equity being unhedged from a currency perspective with a bias to developed markets;
• being underweight both cash and Property; and
• within fixed income having minimal exposure to interest rate risk with a preference for credit.

For the Australian equity component the main themes included:

• being underweight retail banks and overweight non-bank financials;
• being overweight both Industrials and Materials in the ‘Blend’ and ‘Growth’ equity options only

How did these tactical allocations fare in 2013? This is probably best answered by doing a quick review the major market trends last year.

With global growth continuing to improve and central banks around the world still providing liquidity and suppressing borrowing costs, growth assets massively outperformed defensive ones.

The MSCI All-Country World Index of 44 markets rallied for the biggest gain since 2009 as investors’ embraced equities. Stock indexes in all 24 developed countries rose with 11 recording advances of more than 20%. Amongst the industrialised nations Japan’s Nikkei 225 index was the best performing with a gain of 57%, the highest annual performance for the index since 1972. While not quite as spectacular, the S&P 500 index gained 32.4% which helped drive the market to a new all-time high. The major underperformers were developing countries, with the MSCI Emerging Markets index declining -2.4% on fears of slower Chinese growth and concern around the impact of higher borrowing costs in countries like Brazil and India.

Domestically equities enjoyed a very solid year with the ASX200 index enjoyed a total return of 20.2%. Sector performances however differed markedly with much of the heavy lifting done by the banks while the Materials sector was the only one providing a negative total return as reflected below.

Global bond investors suffered the first declines in more than a decade as average yields rose from record lows in anticipation of US Fed tapering, with the Bloomberg USD Investment Grade Composite Bond Index declining -2.2%. Domestically bond investors fared better with the UBS Composite Bond Index 0+ years managing to eke out a gain of 2.0%. As was the case overseas, longer dated bonds more sensitive to interest rates underperformed shorter dated bonds. With risk appetite improving credit spreads continued to narrow (a positive for investors), with the iTraxx Australia CDS index closing the year below 100bps for the first time since 2009.

Cash deposit rates continued to drop as the RBA cut the target cash rate to a record low 2.5%. With inflation averaging 2.3% during the year the real return for most investors after tax was negative. Certainty of capital value does come at a price.

The local currency experienced broad based weakness falling against 14 of 16 major peers in 2013 – on a trade weighted basis the A$ declined -10.6%. It fared even worse against the major currencies down -17.3%, -16.1% and -14.0% against the Euro, British pound and US dollar respectively.

So in essence, the tactical positioning within client portfolios was on balance overwhelmingly successful in adding value during 2013. The major disappointment was being overweight Material stocks in preference to retail banks which detracted substantially from relative performance for our Australian equity allocation.

As we look ahead to 2014 we are broadly persisting with the aforementioned tactical positions as we expect the grinding global economic recovery to continue, the reduction of bond buying by the Fed to again weigh on rates and the A$ to remain weak as Australia transitions to non-mining led growth. Despite the negative impact on economic growth from the mining capex peak, we see mining companies benefitting inter-alia from capital allocation & cost control discipline as well as increased volumes. These views are however constantly subject to review and we will adjust portfolio positions as deemed appropriate.