The value of assets

There is a hope we have entered a new investment era that could open up a period of dynamic asset allocation. Andrew Holt analyses the investment strategies open to charities


FOR CHARITIES assessing an investment approach, asset allocation is where it all begins. As an investment strategy it attempts to balance risk versus reward by adjusting the percentage of each asset in an investment portfolio according to the charity’s risk tolerance, goals and investment time frame. It is central to how any charity tackles the whole idea of investment and having an effective investment approach.

A fundamental justification for asset allocation is the notion that different asset
classes offer returns that are not perfectly correlated, hence diversification reduces the overall risk in terms of the variability of returns for a given level of expected return. Asset diversification has been described as “the only free lunch you will find in the investment game.”

The theory of asset allocation has been explored in academic studies. “According to investment management theory, or at least one of Grinold’s basic versions of it, a manager’s ability to generate outperformance is a function of the opportunity set and the manager’s skill. So, the more active positions you can take, and the more skill you have in taking those active positions, the more alpha you will be able to generate,” says Francois Zagame, head of portfolio management and asset allocation at Old Mutual Asset Managers. “Academics can sometimes resemble a hungry dog digging for a bone and getting so excited with the digging that they lose sight of the big picture,” adds Zagame.

The so called traditional asset classes are: equities, bonds, and cash. There are alternative assets: commodities: precious metals, nonferrous metals, agriculture and energy; commercial or residential real estate (also REITs); collectibles such as art, coins, or stamp; insurance products, that is annuity, life settlements, catastrophe bonds, personal life insurance products; derivatives, such as long-short or market neutral strategies, options, collateralized debt, and futures; foreign currency; venture capital; private equity; distressed securities; and SWAG: silver, wine, art and gold.

Waverton: meeting objectives
There is a hope we have entered a new investment era that could open up a period of dynamic asset allocation. This was highlighted in the eras identified by the Barclays Equity Gilt Study that 1982-2008 was The Great Moderation; 2008-2012 The Great Crisis; with 2013 onwards being something of a question mark.

Therefore, which approach should be used by charities, when, and why? James Pike, head of charities at Waverton Investment Management, says: “Selecting an appropriate investment strategy for a charity is broadly about meeting the needs and objectives that will be demanded of the portfolio and a fund manager using the characteristics of different investments to give us the greatest possible chance of meeting these objectives.

“Despite a poor recent experience [of blending assets to spread risk due
to positive correlation] we believe the importance of this should not be
underestimated as asset allocation positioning is the primary access to diversification benefit, described by some as ‘the only free lunch in finance’.”

Charity objectives differ a great deal.“Thus we believe asset allocation is the most appropriate place to start when tailoring a portfolio, the objective probably being the biggest initial driver of asset allocation,” says Pike.

Taking into consideration the historical and forward looking assertions of each
asset class and combining these together with the portfolio objectives is not an exact science, however. “We use sophisticated tools with conservative assumptions to help improve the chances of success. Together with a sensible spending and reserves policy, this should help trustees ensure the perpetual aim of a charity whilst they are at the helm,” says Pike.

Return objectives usually centre around the needs of the charity which flow through into the expected demands on the portfolio. “Since no two charities are the same in this regard, managing charitable funds lends itself especially well
to the tailored approach to asset allocation and portfolio construction,” says Pike.

“Charity demands should have a direct flow through into a risk profile and therefore a realistic assessment and understanding of the ‘implied’ risk is extremely important. Typically, an investment manager (and a board) must balance a compromise between risk, return (capital or total) and yield when deciding an appropriate asset allocation mix in both the long term and short term,” adds Pike.

Old Mutual: access every asset
Zagame says that when it comes to asset allocation, he believes that, especially in the case of charities, a simple and flexible approach is preferable to sticking to a rigid allocation between different asset classes in a portfolio. “You want to be able to access every possible asset class...

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