Gavin Rankin, EMEA head of managed investments at Citi Private Bank, explains why what you don’t hold is as important as what you do.
'The portfolio solutions team within Citi Investment Management oversees core, globally diversified multi-asset class portfolios for ultra-high net-worth clients of Citi Private Bank. The business runs approximately $13.5 billion (£10.3 billion) in assets spanning the globe, with a broad selection of models – including global and home bias, with and without alternatives – across the entire risk spectrum.
Portfolios are constructed using a three part process bringing together strategic asset allocation, tactical positioning and manager selection in an effort to incorporate the best ideas of our quantitative research group, global investment committee and manager research team on an ongoing basis.
We believe strategic asset allocation is the foundation of any long-term investment portfolio and often does not receive the attention it warrants, especially considering that it accounts for the bulk of the return on an investment portfolio. Much more focus is often placed on shorter-term tactical positioning and manager selection, both of which are crucial as part of a disciplined approach to portfolio management, but usually only add incremental value over time.
Our strategic asset allocation methodology is called adaptive valuation strategies (AVS).
AVS is designed to try and avoid the pitfalls of many traditional methodologies, which failed to estimate the poor returns on equities and were unprepared for the severe sell-offs in risky assets in the decade from 2000.
It is grounded in principles established through academic research and proven in practice, including diversification across four dimensions (asset class, geography, sector, and factor), systematic rebalancing, staying fully invested, and incorporating longer historical data into the analysis.
Unlike many other models, AVS utilises a risk/return framework based on extreme downside risk and current valuations. Here risk is measured in terms of the worst potential loss that a particular allocation may suffer within a rolling 12 month period over 10 years. Returns are estimated based on relative richness/cheapness of an asset class using metrics such as the Cape (cyclically adjusted price to earnings ratio) compared to their long-term averages. This all adds up to a strategic allocation much more grounded in reality with the flexibility to adapt over time to different market conditions.
Looking under the surface at the actual asset allocations, we believe what’s not in our core strategic allocation is just as important as what is in there and we focus on quality and simplicity when constructing portfolios.
We try to avoid including sectors that are merely different types of strategies rather than asset classes, as that often leads to over-diversification and a dilution of returns over time. If thought about in general terms, there are effectively two highly distinct asset classes: equity and debt. Everything else is either a variant/derivative of these two or an alternative style employing them.
We have flexibility to utilise a broad range of strategies within these asset classes to reflect our views on the market or short-term tactical positioning. The chart illustrates our strategic allocation for a global growth and income portfolio with moderate risk.
As you can see our core allocation is a high quality mix of global equity and fixed income strategies that provides ample diversification and liquidity without diminishing the potency of any one category. This time-tested core allocation serves as the bedrock to preserve and grow our clients’ wealth over time, while maintaining the flexibility to reposition tactically and supplement with opportunistic investments as they arise.
Our next article will discuss how we dynamically enhance the risk/return profile of our portfolios using tactical allocation, rebalancing, and manager selection as well as our current positioning and views going forward.'