Each Harmony Portfolio has a long term strategic asset allocation (SAA). This represents a combination of major asset classes which, held over the long run, would meet the return objectives of each portfolio whilst reducing volatility in order to smooth the investor’s journey. The SAA should be used as a guide to the approximate levels of risk and return that the portfolio is designed to deliver and the investment team will target.
The SAA is the starting point, or neutral position, from which the portfolio is built. It is not treated as a benchmark because the focus is instead on generating strong risk-adjusted returns, on an absolute rather than relative basis. As such the investment team is free to deviate meaningfully from the strategic asset allocation based on the opportunity set and relative valuations. However, the aggregate level of risk will never vary substantially from the SAA, so as to provide a degree of certainty to investors that their portfolio remains appropriate for their circumstances.
Our approach to setting strategic asset allocations does not rely on historical returns of different asset classes, as these are not necessarily a good guide to future returns. Instead we place much greater emphasis on the historical volatility of asset classes and covariance with other asset classes. This enables us to define a robust strategic asset allocation of truly diverse asset classes, optimally combined to achieve the desired returns with as little risk as possible, whilst also minimising the probability of shortfall versus objectives. Our analysis uses decades of historical data reflecting our belief that long term historical asset class returns can be used to isolate the risk premia in asset classes; these differences in returns across asset classes will usually persist and drive future returns. One key output from this process is that 30% of the SAA is outside of the ‘home’ region / country, on a non-currency hedged basis, in order to increase portfolio diversification.
By combining assets that vary in response to the forces that drive markets, more efficient portfolios can be created. This is shown graphically below. Efficient portfolios are those that maximise return for a given level of risk or minimise risk for a particular return. This improves the robustness of investment results and reduces the variability of return outcomes.