How Portfolio Managers Tackle Asset Allocation

This analyst blog is part of our coverage of the 2016 Morningstar Investment Conference.

Moderator Jeff Holt started with a poll for the panel: What stock/bond asset allocation returned the most over the past 15 years? 60/40, 80/20, or 40/60? Everyone who raised a hand got a right answer: $10,000 would have grown to nearly $23,000 with any of the allocations. However, although the outcome was the same, investor experiences would not have been, given the different levels of volatility along the way.

Balancing investor needs, goals, and risk tolerance is a challenge of building target date strategies and other multiasset portfolios. Panelists Ebrahim Busheri of Manning & Napier, Matt O'Hara of BlackRock, and Wesley Phoa of Capital Group (American Funds) represented varying approaches to the same end, as the glide paths of their firms' target date offerings look quite different.

Phoa and Busheri emphasized security selection as well as asset allocation can be customized to the end client. Busheri said in recent years, Manning & Napier has shifted more to growth-oriented equities for younger investors, in keeping with the view that companies that can generate their own growth will outperform in a subpar economic environment. Phoa agreed, adding that once an investor is within 10 years of retirement, lower-risk dividend paying stocks are more appropriate.

O'Hara questioned the long-term advantage to be gained by such tilts within an asset class, noting that BlackRock's index target date funds offer attractive risk/reward profiles for low costs. That said, given the fact that bond yields are so low and equities are not cheap, BlackRock's actively managed option may be more attractive to some at the moment.

Busheri said Manning & Napier sees opportunities to add value over the long term with both bond and stock selection, as well as with asset allocation. Phoa underscored the long-term view, noting "We wouldn't call it tactical asset allocation; we have a strategic allocation. With target date glide paths, we want to deliver consistent objectives, without too much downside. You need to adjust allocation according to the environment. So when we started to anticipate increased equity market volatility, we dialed down equity exposure."

Given low expectations for stocks and bonds, Holt wondered whether alternative investments merit a place in target date portfolios. Busheri said Manning & Napier has explored alternatives, and does currently write puts and calls on stocks already held in the portfolio. Phoa noted that hedge funds provide an example of "smart people digging up different investment ideas"--the trick is figuring out how to incorporate them in low cost, transparent portfolios. The irony of 401(k)s, observed O'Hara, is that their investors have long time horizons that would allow for less-liquid investments, but the requirement of daily pricing precludes such holdings. BlackRock does incorporate long/short strategies, however.

A conference attendee pressed for more examples of current opportunities. Phoa said hile nothing looks cheap at the broad asset class level, there may be a lot of opportunity if you look closer--the key is to build in at the portfolio construction level flexibility to move rapidly when individual security opportunities arise. Busheri said Manning & Napier is underexposed to deep cyclical companies, and on the fixed-income side more exposed to corporates. BlackRock has the flexibility to buy high yield and overseas debt tactically, but isn't at the moment, said O'Hara; meanwhile the equity portfolio retains a home bias because opportunities elsewhere aren't attractive enough to warrant a tilt toward international.