Volatile Markets 22.07.2020

This week’s blog is a collaboration between myself and Chris. Chris is very technical, so I have tried to put into Layman’s terms the concepts he is trying to get across. I hope I have been successful and illustrating some of the complexity involved with putting investment portfolios together. And how we work together with Square Mile and our other investment partners.

Markets have been incredibly volatile, and valuations remain quite high, which can present challenges in the creation of strategic asset allocation models. Essentially, strategic asset allocation models, as run by Square Mile for us, work within strict long term parameters. For example, they are based on a model that looks appropriate for about 10 years and will deviate from that model as markets require. However, at Tarvos wealth we will allow them only to deviate within agreed limits. This ensures that they cannot move away from a diversified investment strategy and, for example, put everything into equities just because the manager fancies equity markets. The approach still needs to consider portfolio positionings during times of market volatility.

Strategic asset allocations provide a robust risk and return framework but are based on long-term asset class views. However, in the short term they can oversimplify the world, as the indices that are used to describe those asset classes can change over time. We feel it is important to highlight a couple of good examples that the recent crisis and resultant volatility has caused that we had to consider when putting portfolios together to counter these risks:

  • The S&P 500 is the most frequently used index to describe the US market. Today, only five stocks account for 25% of that index: a significant change from their historic weightings.
  • Within the gilt market, the government has been issuing bonds with a much longer duration than they have done historically. In doing so, the government has taken advantage of lower interest rates to lock-in lower payments for longer. However, this has had the effect of increasing the interest rate sensitivity of the index.

Finally, turning to property, the complexity of measuring this asset class makes it problematic. A good strategic asset allocation model should be easily measurable and investable. However, it is not possible to invest in the Investment Property Databank Index, the index describing property, nor is it easy to measure at present given the funds are closed due to the implications of Covid 19. This presents a technical, quantitative reason for as to why it is not attractive.  In addition however, the long term risk return outlook for property is not favourable in our view, and so if there is to be no exposure to property within the model portfolios, it makes sense to eliminate it within the strategic asset allocation and therefore measure returns against it.

Perhaps the above gives some explanation as to how and why we work so closely with experts such as Square Mile and why we need to bounce off each other to ensure that our clients’ expectations are met.

Chris Fleming, Investment Services Director Square Mile
Simon Ludden, Managing Director Tarvos Wealth