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Strategic Asset Allocation Update for the Risk Managed Funds

5 min read 3 Oct 22

This content has been prepared by M&G Treasury and Investment Office (T&IO) and is prepared for information purposes only and does not contain or constitute investment advice. Information provided herein has been obtained from sources that T&IO believes to be reliable and accurate at the time of issue but no representation or warranty is made as to its fairness, accuracy, or completeness. The views expressed herein are subject to change without notice. Neither T&IO, nor any of its associates, nor any director, or employee accepts any liability for any loss arising directly or indirectly from any use of this document. The value of investments and any income from them may go down as well as up and are not guaranteed. Investors may get back less than the original amount invested and past performance information is not a guide to future performance.

‘M&G Treasury & Investment Office (T&IO)’ includes the team formerly known as Prudential Portfolio Management Group (PPMG). Prudential Portfolio Management Group Limited, is registered in England and Wales, registered number 2448335.

Strategic Asset Allocation Review

This year’s annual review of the long-term positioning of the Risk Managed and Risk Passive fund range was carried out against a background of inflation at the highest level for decades and rising central bank rates.

Much of the increase in inflation has been the result of Russia’s invasion of Ukraine, which has exacerbated supply chain problems already under strain from the pandemic. As central banks have tightened policy, fears of recession have mounted.

We started to reduce risk and add some inflation protection to the portfolio last year amid concerns that supply chains would come under pressure. Our approach was to ensure that we not only held assets that provide a hedge against inflation, but that also provide an additional investment premium. One area we have built exposure has been real assets, which historically during periods of high inflation has been one of the best performing areas of the market.

Cognisant of the current inflationary environment, we are keen to build on this real assets allocation within the funds and at the same time increase the diversification. We continue to tilt fixed income exposure towards Asian and emerging markets, which we believe offer better potential investment opportunities. Within the equity allocation we are trimming some of the exposure to the UK market, which has outperformed over the past 12-months. Some of these profits are being recycled into the US and Asian equity markets.

Key Changes

Property, Infrastructure and Alternatives – add overseas exposure

Over the past year, we have built a significant and diversified allocation to real assets that offer medium to long term inflation hedging characteristics. This exposure includes property, infrastructure, private equity and hedge funds.

For the active range, we are tilting the alternatives allocation towards infrastructure assets which are both a better inflation hedge and have lower fees compared to the private equity and hedge funds allocations. The savings made from the rebalancing of the alternatives allocation will contribute towards a small increase in the property allocation. Further funding will also come from small adjustments to the equity and fixed income allocations.

Within the property allocation of the active range we are also raising exposure to overseas property. This will take the regional breakdown to 60% UK and 40% overseas property. This adjustment will both help the diversification of the portfolio and should, in our view, provide better investment opportunities.

For the passive range, there is an additional fee constraint within the asset allocation process. Cognisant of this, we are switching the current alternatives exposure within the passive range to property. This enables us to maintain the real estate exposure, which provides the strong inflation hedge for the funds, but at a more competitive price and therefore overall better potential return profile for clients.

Fixed Income – increase exposure to Asia and emerging markets

In response to the multi-decade high levels of inflation central banks have hiked interest rates significantly. Nonetheless, because inflation remains so high, real fixed income returns in developed markets remain negative. By contrast in many Asian and emerging market economies inflation has not risen nearly as much. Central banks in these countries therefore have substantially more room for monetary stimulus. We continue to build exposure to these regions within the active portfolios.

In our view Asian fixed income is well positioned to benefit from the broadening and deepening of its market as well as the structural reforms and growth of a strong domestic investor base. The picture is not uniform across Asia and the fact that economies are at different stages of the monetary cycle should provide opportunities for active managers. In emerging markets we are seeing an increase in idiosyncratic risk. For active managers this dispersion across regions should provide investment opportunities. For the fund this allocation should help diversification and offers the potential for higher returns compared to developed markets.

Across risk managed funds 1 and 2 in both the active and passive ranges (the lowest risk funds) we are increasing overall fixed income exposure by 2.5% in fund 1 and 1% in fund 2. This increase is funded from equity and will therefore reduce the overall risk profile of all four funds.

Equities - small increases

As part of our overarching strategy of reducing risk we are scaling back some of the fund’s UK equity exposure. The UK equity market has seen strong performance over the past year and in our view has the least attractive outlook. Proceeds from sale will be used to fund small increases in North American, Asian, Japanese, Chinese and Indian exposure.

The North American market is likely to benefit from an earlier recovery compared to rest of the developed economies whilst Japanese equities are becoming more attractive due to corporate reforms and currency depreciation.

Inflation in Asia, India and China is significantly less severe than in the developed economies which enables them to adopt more growth oriented policies. India in particular is well positioned in our view to benefit from a larger share of global trade in services.

Target Strategic Asset Allocation

Active Range

	Risk Managed Active 1	Risk Managed Active 2	Risk Managed Active 3	Risk Managed Active 4	Risk Managed Active 5
	Target SAA%
UK	5.90	9.91	14.27	18.52	22.80
Europe ex. UK	2.27	3.82	5.50	7.14	8.80
North America	2.28	3.82	5.50	7.14	8.80
Japan	1.26	2.12	3.06	3.97	4.89
Asia ex. Japan	2.70	4.53	6.52	8.47	10.42
China	0.76	1.27	1.83	2.38	2.93
India	0.25	0.42	0.61	0.79	0.98
Global Emerging Markets	0.67	1.13	1.63	2.12	2.61
Middle east and Africa	0.76	1.27	1.83	2.38	2.93
Total Equity	16.85	28.29	40.75	52.91	65.16
UK	2.85	3.88	4.65	5.05	6.00
Europe ex. UK	0.71	0.97	1.16	1.26	1.50
Asia	1.19	1.62	1.94	2.10	2.50
Total Property	4.75	6.47	7.75	8.41	10.00
Private Equity	0.30	0.43	0.57	0.63	0.70
Hedge Fund	0.30	0.43	0.57	0.63	0.70
Infrastructure	0.60	0.85	1.14	1.26	1.40
Total Alternatives	1.20	1.71	2.28	2.52	2.80
UK (Investment Grade)	28.53	22.30	16.12	11.01	6.52
Europe (Investment Grade)	5.83	4.52	3.27	2.23	1.26
US (Investment Grade)	14.52	11.00	7.83	5.60	2.95
US Treasury	2.55	2.11	1.64	1.20	0.74
Asia	12.40	11.15	9.34	6.88	4.21
Global High Yield	3.28	4.07	3.97	3.53	2.52
Convertible Bonds - Global	1.46	1.21	0.93	0.69	0.42
Emerging Market Debt	4.38	3.92	3.62	3.27	2.42
Total Fixed Income	72.95	60.28	46.72	34.41	21.04
Cash	4.25	3.25	2.50	1.75	1.00

Passive Range

	Risk Managed Passive 1	Risk Managed Passive 2	Risk Managed Passive 3	Risk Managed Passive 4	Risk Managed Passive 5
	SAA Weight%
UK	7.77	11.75	16.09	20.31	24.70
Europe ex. UK	3.22	4.87	6.67	8.41	10.23
North America	3.00	4.53	6.21	7.83	9.53
Japan	1.66	2.52	3.45	4.35	5.29
Asia ex. Japan	3.72	5.62	7.70	9.72	11.82
China	0.55	0.84	1.15	1.45	1.76
India	0.33	0.50	0.69	0.87	1.06
Global Emerging Markets	1.39	2.10	2.87	3.63	4.41
Middle east and Africa	0.55	0.84	1.15	1.45	1.76
Total Equity	22.19	33.57	45.98	58.02	70.56
UK	0.48	0.61	0.73	0.79	0.86
Europe ex. UK	0.32	0.41	0.49	0.53	0.58
Total Property	0.80	1.02	1.22	1.32	1.44
UK (Investment Grade)	33.05	27.70	21.94	16.52	11.12
Europe (Investment Grade)	10.75	8.98	7.09	5.30	3.54
US (Investment Grade)	17.39	14.56	11.49	8.59	5.72
US Treasury	2.55	2.18	1.76	1.36	0.94
Asia	3.64	3.11	2.51	1.95	1.35
Global High Yield	2.11	2.52	2.62	2.47	2.03
Emerging Market Debt	3.27	3.11	2.89	2.72	2.30
Total Fixed Income	72.76	62.16	50.30	38.91	27.00
Cash	4.25	3.25	2.50	1.75	1.00

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