We’re Re-Optimising Your Portfolios for Uncertain Times Ahead

14 May 2020
Freddy Lim

Though the March market crash was paralysingly fast compared to the 2008 financial crisis, the depth of the market crash was not as pronounced as that of the 2008 recession. This time around, central banks matched the speed of the recent crash with quick economic stimulus packages. The fast responses prevented a steeper and more prolonged market crash as the market quickly priced in an average recession, rather than a deep recession. Still, the depth of the oncoming recession remains unclear for now. With that said, we know that the markets and the economy will eventually recover, though we don’t know what the path to recovery will look like.

Our investment framework, ERAA®, has analysed the latest economic and market data; we are now re-optimising our portfolios to better prepare them for what lies ahead by reducing US Dollar exposure, increasing Chinese exposure, and for some portfolios, increasing exposure to Gold. This is the second time we have re-optimised our portfolios since our launch in Malaysia in November 2018.

What we’re adjusting to prepare for the foreseeable economic environment

In both principle and practice, if the markets have already priced in a recession, there’s no need to change a portfolio’s asset allocation to prepare for the recession. So, instead, we’re re-optimising our portfolios to have a balance of growth and protective assets that can better navigate the expected economic uncertainty in the foreseeable future. Preparing a portfolio for future uncertainty is referred to in our investment framework, ERAA®, as an All-Weather strategy.

Adjusting for valuation gaps to look ahead, not to react to the past

In mid-August 2019, we moved all of our portfolios to an All-Weather strategy for assets exposed to non-US economies, and kept the exposure to US assets growth-oriented. We did this because non-US economies were facing relatively larger economic uncertainty compared to the US. Now, in this re-optimisation, we’re managing the high global economic uncertainty by moving all portfolios to an All-Weather strategy for all assets.

Before re-optimising a portfolio to prepare for what’s ahead, ERAA® evaluates the valuation gaps of asset classes to address the higher risk inherent in an overcrowded and overvalued asset class. This valuation gap adjustment also efficiently allocates your funds by investing in different assets with smaller valuation gaps yet comparable risk. Our valuation gap analysis refines the economic base-case of expected returns by making expected returns and risk estimates forward-looking instead of historical.

Decreasing USD exposure

In our re-optimisation in August 2019, ERAA® increased the overall US Dollar exposure across all risk points, taking account of the broad economic uncertainty. ERAA® did this because, as the US Dollar is seen as a safe-haven currency, it tends to appreciate when the markets get more nervous.

When we made those changes in August 2019, we certainly didn’t foresee a global pandemic in the near future, but as a result of the risk management measures, our portfolios were already braced for the economic uncertainty that preceded and lingers with COVID-19. The exposure to the US Dollar (a key funding currency) is one of the factors that allowed our portfolios to endure March’s market crash.

We are now reducing our US Dollar exposure. There’s a ton of money being “printed” in the economy right now because of the economic stimuli. While many governments are taking economic measures, the US Government and the Federal Reserve have been particularly aggressive. Although the stimuli are in place to prevent a deeper recession, they could also lead to significant depreciation of the USD as the economy gradually recovers. We saw this depreciation happen after the US Federal Reserve introduced quantitative easing in March 2009. Then, the US Dollar depreciated by 21.2% versus the Ringgit between March 2009 and July 2011.

Introducing Chinese Technology to the ERAA® universe

As we move to an All-Weather strategy for all assets, and move away from growth-oriented assets in the US economy, we’re increasing our exposure to China.

For USD-denominated portfolios, we’re introducing a new ETF, China Internet (KWEB:arcx), to introduce a non-US growth-oriented asset class with long-term potential. The Chinese Technology sector is now a key part of the 2nd largest economy in the world. The China Internet ETF, along with AAXJ (Asia ex-Japan equities, which has a 39% exposure to China) will provide more opportunities for our portfolios. To add the China Internet allocation, ERAA® is reallocating funds out of European equities and US Energy, as well as significantly reducing allocations in Emerging Markets, and slightly reducing allocations in US small-cap.

For GBP-denominated portfolios, we are increasing exposure to China by investing in EMIM, which is an ETF that tracks the MSCI Emerging Markets Index. China represents 33% of the exposures in EMIM. Additionally, EMIM has a combined exposure of 26.5% to technology and telecommunications across China, South Korea, Taiwan and other markets within the Emerging Market spectrum.

For some portfolios, increasing positions in Gold

Despite the run-up in Gold prices this year, we will raise, and, in some cases, maintain Gold allocations. Gold has proven to be an asset that provides portfolio insurance against market crashes. It also offers protection against the dilution of paper money. The latter has become a rising concern amongst investors globally given the massive monetary stimuli introduced by central banks around the world to support the economy against COVID-19.

Aside from offering portfolio insurance, Gold remains undervalued: Gold’s valuation gap is around 5.7% per annum.

Your portfolios are prepared for what’s ahead

Despite the extreme volatility recently, almost all of our portfolios outperformed their same-risk benchmarks. In other words, they experienced less severe drawdowns compared to their benchmarks that have the same risk exposure. Our portfolios resiliently faced March’s market crash, and now looking ahead at uncertain economic times, these adjustments to your target asset allocations will prepare you for what lies ahead.

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