Asset allocation
6 min read 5 May 23
In this piece we consider our asset allocation in more detail. We look at the aim of our asset allocation and why we have a higher allocation to Asia and emerging market equities.
The Strategic Asset Allocation (SAA) is the mix of asset classes held in each M&G Wealth model portfolio. The aim of the SAA is to find the best combination of assets that will meet clients’ objectives over an economic cycle (typically 5 – 10 years). We decided how to invest now in order to capture future opportunities, cutting through the day-to-day noise of markets.
Coming up with the SAA is a key step in our investment process. The Long -Term Investment Strategy team (LTIS), part of the M&G’s Treasury & Investment Office, sets the Strategic Asset Allocation for PruFund, PruFolio and our model portfolio services. The SAA and assumptions that underpin it are regularly reviewed, as the team test the views and their sensitivity to developments in the economy and capital markets.
One of the main views we have in our SAA is to investing more in Asia and emerging market equities. This is based on more favourable demographics and better regional trade dynamics. Establishing future economic opportunities is a key input when thinking about which asset-classes are going to deliver the best returns going forward.
In Western economies, the post-war decades saw a burst of population growth that led working populations to grow rapidly and support economic growth. Recent decades have seen fertility rates in these countries fall steadily and this is bringing about a turning point for demographics in these economies on two fronts: (1) fewer young people are entering the workforce and (2) a significant portion of the population is getting closer to retirement.
Other regions offer brighter prospects. Asian and African populations are set to rise over the next 30 years. In India, people under the age of 25 account for more than 40% of the population. There is also less of a burden from an ageing population; adults aged 65 and over comprise 7% of India’s population compared to 14% in China and 18% in the US1.
Alongside a growing relative weight in global activity, the LTIS team’s analysis of global trade flows indicates that a greater degree of trade for emerging markets is intra-regional with other emerging market countries, suggesting there is an increasing degree of internally generated activity.
Developed markets, and in particular the US, will still have a significant impact on the economic growth of emerging market in coming years. However, there’s scope for internally generated demand to help emerging markets to become more independent of developed market economic cycles over time. We expect the economic centre of gravity to shift over time.
The market value of domestic stock markets tends to be closely tied with the size of their economy. When comparing market values between regions we see a large concentration is weighted toward developed economies, which is disproportionate to their relative economic weight at current levels of GDP. This contrast is even more stark when viewed in the context of contrasting growth outlooks. The chart below shows the size of the economy (inner ring) versus the global equity benchmark weight.
We think the market value of equities tends to move with economic size, and Asia and emerging markets are underrepresented currently. By having a greater allocation now, we hope to capture this shift over the coming years.
While long term growth prospects offer compelling arguments to invest in emerging markets, there are significant risks as well. Emerging markets can be more volatile and tend to have weaker investor protections. Economic data can be less reliable. Currencies can be more volatile, impacting the overall return from equities. The relationship between China and the United States has been strained in recent years. We think the economic benefits that China and the US receive from trade are too large for either country to seriously consider ending the relationship. For China, ending economic relations with the US would lead to a sharp downturn in China’s economy.
Our investments are diversified across different countries within emerging markets. We think local market expertise is required for managing these investments and our preference is for managers with a local presence who understand the country-specific risks and have a track record of managing investments in these markets.
Past performance is not a reliable indicator of future performance. The value of an investment can go down as well as up and your client may get back less than they’ve paid in.
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