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Global Balanced Strategies

Investors continue to think globally.

Cara Esser, 04/26/2013

ETF managed portfolios are investment strategies that typically hold more than 50% of portfolio assets in exchange-traded funds. Primarily available as separate accounts, they represent one of the fastest-growing segments of the managed account universe. Morningstar has developed a proprietary classification system for ETF managed portfolios that identifies the investments’ portfolio attributes. The new structure consists of four main attributes: universe, asset breadth, portfolio implementation, and primary ETF exposure type. This system helps investors better understand the philosophies underlying these investment strategies. The latest Morningstar ETF Managed Portfolios Landscape Report (which can be found here) is a comprehensive industry review of strategies that report information to Morningstar’s separate account database. 

In this series we’re taking an inside look at the industry using the combination of universe and asset breadth attributes as a starting filter. This commentary is focused on global (universe) balanced (asset breadth) strategies, and upcoming commentaries will discuss other attribute combinations. 

Thinking Globally
Global investment strategies have profited from an investor base that is growing increasingly comfortable with investments beyond their own borders. Despite concerns over China’s soft landing and continued troubles in the eurozone, enticing growth prospects exist in certain developing and emerging economies. Managers and pundits also have a relatively positive view on the slow but steady recovery in the U.S. economy. What’s more, the appeal of balanced funds has grown as investors have increasingly decided to leave allocation decisions to managers. The rise of target-date mutual funds has allowed investors to become more comfortable with a relatively hands-off approach to allocation as investment horizons change. A fast-changing and interconnected global economy calls for a more balanced and nuanced approach to investing. Enter global balanced ETF managed portfolio strategies that invest across borders and asset classes. Morningstar currently tracks more than 90 of these offerings. 

Global balanced strategies are the fourth-largest universe and attribute combination, but its total assets are less than half of the top two combinations (global all-asset and U.S. equity) as of the end of 2012. Growth in the number of strategies has not been as strong as other universe and attribute combinations, but nearly all of the global balanced strategies saw an increase in assets during 2012. 

Collectively, balanced strategies have matched the growth rate of 60% seen for all ETF managed portfolios. Through December 2012 balanced strategies as a whole accounted for 9% of total ETF managed portfolio assets. But within that group global strategies have been the focal point, with assets up 70% last year and now accounting for 82% of assets in balanced strategies. 

Investing Across the Universe
The global balanced strategies are fairly top-heavy, with the 10 strategies accounting for 63% of the group’s total assets. The largest strategy, Riverfront Moderate Growth and Income, makes up 22% of assets and is nearly 3 times the size of the group’s second-and third-largest strategies from Morningstar Associates (ETF Portfolio Moderate Growth and ETF Portfolio Growth). Riverfront Moderate Growth and Income grew about 32% in 2012, a modest change in percentage terms, but one of the largest in terms of absolute dollar growth. One of the smallest global balanced strategies (Integrated Managed ETF Risk Controlled Growth) grew assets 680%, from $3 million to $24 million. The focus on risk, specifically mitigating volatility, is popular in this asset breath and universe combination. A suite of strategies from Innealta Capital (16 in all, six in the global balanced combination) concentrate on risk-adjusted returns by allocating to asset classes based on various risk/reward characteristics of the underlying securities and overall views on market movements. 

Retirement is another focus of many of the global balanced strategies, broadening the appeal to a wide array of clients. Wela Strategies, for example, offers allocation strategies modeled after the immensely popular target-date mutual funds. The Own Your Age suite includes nine strategies in all (ranging from ages 20 to 70, corresponding to a client’s current age, and including All Growth, Conservative Yield, and Aggressive Yield strategies). Allocations are based on life stage and change as time passes. Three of the nine are global balanced strategies (40, 50, and 60) because of their life cycle portfolios that are fairly balanced between equity and fixed-income ETFs. 

Portfolios Hanging in the Balance
Like the broader ETF managed portfolio universe, global balanced strategies typically employ a combination of technical and quantitative factors. Statistics such as momentum, moving average, relative value, relative volatility, and various yield-curve scenarios often form the basis of model inputs. Other factors such as mean reversion or mean variance optimization can also play a role in determining portfolio holding weightings. About 40% of the strategies fit the “All-Inclusive” primary ETF exposure type label, providing relative freedom to managers in choosing underlying funds. As a result, investors should expect these funds hold sector, regional, single-country, and broad-market ETFs inside the strategies’ portfolios. On the whole, a “balanced” portfolio will generally allocate to equity, fixed-income, and alternative ETFs and global balanced funds will allocate between domestic and international ETFs. A more tactical manager may move quickly into and out of asset classes based on overall market outlook, while a strategic manager may keep the allocation relatively static within a specified range. 

Because these strategies are wide-ranging, macroeconomic data plays a large role in allocation decisions between fixed income, equity, and cash. The data is also combined with a macro view on individual countries and regions. Understanding and predicting growth rates, inflation rates, currency movements, gross domestic product, and consumer consumption data are often key factors in the strategies’ models. Managers are aiming to minimize relative risk or even anticipate price momentum appreciation. In addition to the quantitative signals, the strategists may inject a qualitative idea from an investment committee or portfolio manager. In these cases, the portfolio manager should be able to clearly demonstrate how such qualitative inputs have improved the strategy and how the structure allows for consistent application of these views going forward. This should be a key discussion point for potential investors. 

Understanding the strategy’s scope and objective is crucial to using it correctly within a broader portfolio. Decision-makers must have a clear view of the importance of factors such as upside participation, downside-capture, and correlation. A strategy’s portfolio may quickly move in and out of asset classes, sectors, industries, regions, or countries, while some products may have concentration limits. To better understand any limitations, investors should be sure to understand whether a strategy has set allocation bands related to asset classes, regions, or sectors. Potential attribution and performance analysis versus broad-based, passive ETFs should also focus on the allocation to cash as well as satellite regions such as emerging markets compared with the historical allocation in the portfolios. For tactical funds, it is also important to understand how an investment in “cash” is handled—how exactly is a cash portion invested? By clearly understand these aspects, investors are able to picture what a strategy actually does (rotates into better pockets or offers a degree of downside protection, for example) as well as what is unusual or atypical compared with peers (slight or extreme tactical changes, or leveraged or inverse ETF holdings, for instance). 

Under the Hood
Global balanced strategies are invested in both domestic and foreign stock and bond ETFs, and many hold broad market ETFs including SPDR S&P 500, iShares MSCI EAFE, and iShares iBoxx Investment Grade Corporate Bond. Often, these core holdings are rounded out with sector funds providing exposure to specific regions and sectors as well as commodity and alternative funds like low volatility and long/short ETFs. On the whole, most hold the majority in broad market ETFs with satellite holdings of regional and sector ETFs. IShares’ suite of funds is a popular choice for many of these strategies, with a handful preferring ETFs from Vanguard and SPDR. 

How They Can Be Used
Global balanced strategies can be used in a variety of ways—especially if decision-makers consider the characteristics of the return stream rather than the underlying portfolio holdings. Advisors may invest the core portion of clients’ portfolios in these strategies because of their diversification among asset class and region. Institutions and other large investors can also consider them for an alpha satellite holding or risk-diversifying allocation, depending on their draw-down and volatility-consistency goals. Below we highlight the top strategies based on risk-adjusted return, core/alpha characteristics, and diversification. 

The blended benchmark composition for the correlation calculation is below. Benchmark weights were rebalanced quarterly. 







Going Their Own Way
Global balanced offerings are likely to keep pace with the general growth of the broader ETF managed portfolio universe, and we don’t expect their utility as a core offering to diminish. The rate of growth will likely be influenced by increased interest in allocation, risk-based, and target-date retirement type strategies as well as the speed of the global recovery. Problems in the eurozone and China are likely to cause the market some stress, but the broad mandate of these strategies leaves room for managers to find pockets of growth elsewhere. 

Cara Esser is a closed-end fund analyst at Morningstar.

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