2020 Portfolio Trends Report: Mind the gaps - and biases
27 November 2020 | Topical insights
By Joshua Woodruff, head of portfolio analytics and consulting, and Monika Dutt, portfolio consultant
Have you ever wondered why your portfolio is not performing quite as you had expected? Vanguard has conducted an in-depth analysis to help advisers understand more about the portfolio inefficiencies that could be costing them and their clients valuable returns.
We lifted the bonnet on 91 balanced1 portfolios sent to us by our UK clients between January and November this year. Our aim was to shine a light on their true positioning and the potential impact of unintended gaps, biases and concentrations versus the benchmark2. The resultant analysis revealed hidden trends that may come as a surprise to advisers.
The main structural change we found was that UK advisers had moved away from the 60% equity - 40% fixed income split of a classic balanced portfolio. While equity exposure remained stable, we observed that advisers allocated around a quarter of their fixed income holdings to non-traditional assets such as commodities, direct property and private equity.
In our view, while non-traditional asset classes can introduce diversification benefits, they can also increase costs, lower transparency and reduce liquidity. Furthermore, non-traditional assets delivered a wide range of outcomes, as evidenced by the 25% rally in gold and the 43% fall in oil in the ten months to the end of October3.
Looking at equities, one of the most striking findings was the broad underweighting of US stocks. On average, US equities represented only about 34% of advisers’ portfolios in our study, significantly lower than their average weight of approximately 56% in the global equity market during 20204. This underweighting held back portfolio returns, with the US equity market outperforming global stocks by approximately 5 percentage points from January to October5.
The advisers’ portfolios we examined also had a significant home bias, with an average allocation of approximately 30% towards UK stocks versus a global weighting6 of just 4.4%. Over the period we reviewed, this positioning will have weighed markedly on performance as the FTSE All-Share Index trailed the global average by approximately 24 percentage points7.
However, favouring the home market is often a conscious asset-allocation decision for reasons of familiarity and reduced currency risk. Therefore, a period of underperformance may not be a reason to change the underlying portfolio construction as long as it is still consistent with client objectives.
Our analysis also suggests that regional equity exposures can drive unintended sector positioning and influence returns unexpectedly. We saw, for instance, that a broad underweighting to US equities may have resulted in a lower relative exposure to technology, the best-performing sector over the observed period8.
Equity country and sector tilts can also influence a portfolio’s style biases. Our study found that advisers’ portfolios were underweight to large-cap growth stocks. This appeared to be less of an intentional shift, and more of a consequence of the low relative holdings in big US tech stocks. Once again, we saw how a regional preference can risk unbalancing exposures elsewhere in the portfolio.
Within fixed income we observed a number of trends. The main theme was a reduced government-bond exposure in favour of corporate bonds. Against low yields in government-bond markets, the attractions of corporate debt have risen following their inclusion in expanded central bank asset-purchase schemes. But advisers reducing exposure to government bonds may risk losing the valuable capital-preservation advantages of the asset class when sentiment collapses.
Different asset types, markets, sectors, styles and capitalisation groups will inevitably experience periods of under- and outperformance over time. Indeed, our trends study shows that at times of market dislocation, such as the current Covid-19 crisis, portfolios’ vulnerability to inefficiencies in their asset allocation can become more explicit.
To help ensure valuable performance is not needlessly sacrificed at times of heightened uncertainty, we caution clients to focus on long-term expected returns, adopt a diversified approach to asset allocation and avoid the temptation of trying to time such tumultuous markets.
Our UK team of portfolio consultants examine portfolios from several angles. They analyse their risk and return parameters, as well as their geographic, sector and style biases. Since 2019, they have worked with nearly 200 clients and reviewed more than 300 portfolios.
Find out more about our Portfolio Analytics & Consulting team.
1 We defined balanced portfolios as those allocating approximately 60% to equities.
2 For the equity sleeves of the portfolios, we used the FTSE Global All Cap Total Return Index. For the fixed income sleeves, we used Bloomberg Barclays Global Aggregate Index.
3 Bloomberg data. Gold performance measured by XAU Currency with a BGN pricing source for 02/01/2020 to 30/10/2020. Oil market measured by CL1 Commodity, the WTI front line futures contract, for 02/01/2020 to 30/10/2020. Performance calculated in sterling.
4 Regional weights were calculated for the FTSE Global All Cap Total Return Index for the period 01/01/2020 to 31/10/2020.
5 Morningstar data. Global equity market represented by the FTSE Global All Cap Total Return Index. US equity market represented by the FTSE USA All Cap Total Return Index. Performance calculated in sterling terms for the period 01/01/2020 to 31/10/2020.
6 Morningstar data. FTSE Global All Cap Total Return Index country weights were calculated for 01/01/2020 to 31/10/2020.
7 Morningstar data from 01/01/2020 to 31/10/2020. Returns in sterling.
8 Morningstar data. Daily performance data from 01/01/2020 to 31/10/2020. Performance measured by the MSCI World sector indices (USD): MSCI World/Information Tech NR USD, MSCI World/Health Care NR USD, MSCI World/Comm Services NR USD, MSCI World/Financials NR USD, MSCI World/Real Estate NR USD, MSCI World/Energy NR USD. Returns calculated in sterling.
Investment risk information
The value of investments, and the income from them, may fall or rise and investors may get back less than they invested.
Past performance is not a reliable indicator of future results.
Funds investing in fixed interest securities carry the risk of default on repayment and erosion of the capital value of your investment and the level of income may fluctuate. Movements in interest rates are likely to affect the capital value of fixed interest securities. Corporate bonds may provide higher yields but as such may carry greater credit risk increasing the risk of default on repayment and erosion of the capital value of your investment. The level of income may fluctuate and movements in interest rates are likely to affect the capital value of bonds.
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