My Asset Allocation

Thirteen US interest-rate cuts, three major federal tax reductions, hundreds of billions of dollars of cash-outs on mortgage refinancing and a 30% decline in the dollar appear to have resuscitated the US economy, at least temporarily. But while the market has priced in an enduring global recovery, Fed hints that rates will remain low suggest a note of caution. And record levels of debt are a further worry for the world’s largest economy, and hence for the world at large.

Our fund selection bias is towards stockpickers – they have the flexibility to buy stocks whose fortunes are not solely determined by macroeconomic trends, but can find stock-specific reasons for an upward rerating. High-conviction portfolios, where managers are not compelled to hold a stock on account of benchmark constraints, give greater opportunities to outperform.

However, by attempting to optimise de-correlations between a stable of “aggressive funds” such as SocGen UK Opportunities and Schroder UK Alpha, Berkeley UK Growth & Value has outperformed the UK All Companies sector while relative volatility has been reduced by 12%.

The asset allocation of the Berkeley International Growth & Value fund reflects our macroeconomic concerns. US markets are not cheap; moreover, bull markets, historically, do not start on a P/E multiple of 22x. The fund remains heavily overweight in Asia and emerging markets, which remain on discounted price multiples to their Western counterparts. Such exposure comes via funds such as Thames River Global Emerging Markets, which seeks absolute returns.

The International fund also holds Merrill Lynch Gold & General. The intention is to capture dollar weakness, while also providing a cushion against any market shocks. Again, an overweight position in emerging markets does not confer higher risk; through careful fund selection and blending, volatility in the fund is significantly reduced.

We have underlined our concerns for stockmarkets and intend to avoid, wherever possible, the beta merchants of benchmark-constrained funds. The reality is this: equity mutual funds have correlations of around 0.8-0.9, irrespective of investment style or fund mandate. Moreover, correlations move even closer to 1 in times of market distress. By including hedge funds, which have low correlations with traditional asset classes, we can afford significant diversification benefits to investors.

A fund of hedge funds includes myriad skill-based strategies, and distinguishes itself from other asset classes by the use of these investment and risk management skills to produce positive returns regardless of market direction. This is why we allocate 50% of certain portfolios to various funds of hedge funds, as they allow us to protect the downside and reduce volatility in all market conditions, by virtue of techniques such as short selling and leverage. Historically, funds of hedge funds have produced high risk-adjusted returns, outperforming both global bonds and equities.

Our selections begin with 20% in the Io Low Volatility fund, whose performance over 2003 was 11.78% after fees. We would put 10% in Key Hedge, another multi-strategy fund, which has returned 9% on an annualised basis over its 13-year track record. Finally, 20% goes to GLG Multistrategy, which gives the portfolio more directional bias. This fund has compounded over 20% per annum over the last six years.

Since 1982, we have experienced the largest secular bull market in US history. When this has happened in the past, such as in 1929 and 1965, it has been followed by a 17-20 year secular bear market. It seems injudicious to put a client’s wealth entirely at the mercy of the stockmarket – it is very difficult to spend relative returns when they are negative.

Model portfolio
Capital invested
Berkeley UK Growth & Value £60,000
Berkeley Int’
•Growth & Value £40,000
Io Investors Low Volatility £40,000
GLG Multistrategy £40,000
Key Hedge £20,000