What determines an asset class?
At Andres we define an asset class as a collection of securities that we expect to behave similarly throughout an economic cycle. For example, long dated US Treasury notes and bonds could be considered a separate asset class from Investment Grade (IG) bonds given the credit default risk associated with IG bonds. The credit default risk will drive IG bonds to behave manifestly different than UST notes/bonds at different times throughout the economic cycle. This will result in economically and statistically different investment characteristics. Ultimately, these differences can offer diversification opportunities as we include systematically different exposures within a broadly structured portfolio. There are statistical limits to this process as the temptation exists to add more and more exposures. Eventually more and more granularity does not enhance the portfolio characteristics and so a balance must be made between economically impactful inclusion and noise. With over a century of experience we are confident in where that balance lies.
Our multiple asset class portfolio construction begins with traditional equilibrium based asset allocation. That is, we derive our long-term views across a collection of asset classes using our balanced approach. We then run various optimization and simulation techniques to determine reasonable asset allocations. The inputs used within these quantitative approaches are continuously monitored as we synthesize incoming information but rarely is there an exogenous event that would be so meaningful as to discretely impact our equilibrium targets. Rather, they tend to move gradually as our views are updated through time. This equilibrium asset allocation serves as our base for our everyday wealth management advisory services as well as our global active tactical (GTAA) strategy.
Our equilibrium targets are contingent on the wealth and risk management solution being created to match the needs of the client. The goals and objectives of our clients are a vitally important consideration as we construct the multi-asset class wealth management solution. Investors have different levels of risk aversion as well as varying investment horizons. Our target exposures must account for those characteristics to ensure we create an optimal investment policy for our clients.
Global Tactical Asset Allocation (GTAA) Strategy
Our GTAA strategy starts with our equilibrium-based asset allocation targets and combines top-down and bottom-up research to determine how to obtain or adjust these exposures. It is designed to deliver superior risk adjusted performance by dynamically adjusting the target exposures or by populating the target exposures using instruments that enable us to concentrate in sectors, industries, or even countries where we believe more opportunity exists to add value. Additionally, in some asset classes where we have considerable security level acumen, like fixed income, we will obtain our exposures through the purchase of individual securities. In others, we might deploy Exchange Traded Funds (ETFs) where we believe they are the most cost effective way for us to gain the desired exposures. Regardless of how the exposures are obtained we will always maintain optimal diversification to ensure that our risk is always at the fore of our investment decision process.
Our portfolio construction process involves the implementation of a constrained optimization routine. Our framework enables us to properly manage the risk of the portfolio in a disciplined manner. Our collective experience has taught us that employing a well-structured risk management discipline together with a superior security selection process will lead us to being able to deliver desirable long-term investment performance to our clients.
Portfolio construction is conceptually similar across all of our fixed income strategies. We start with a universe of bonds that meet our security selection criteria. Each bond will possess various attributes that enable us to measure its contribution to the portfolio in terms of risk adjusted expected return. The attributes will also be used to measure investment characteristics relative to our benchmark thus establishing risk constraints. The optimization will then establish a portfolio that simultaneously maximizes risk adjusted expected return and meets our risk constraints.
The framework allows our portfolio managers and our investment committee to perform risk analysis on candidate bonds or to evaluate different interest rate scenarios. This ability is extraordinarily important in active management. It enables our team to measure the effects of active management decisions on portfolio risk prior to implementation and to subsequently monitor risk in a concise manner.
Successful execution is a critical component of our active management process. While we employ various strategies from credit and yield curve analysis to duration management, and a host of other valuation metrics to help drive returns for our clients, what is not fully understood by many investors is the value-added derived from expert securities execution. We believe that every incremental basis point of return is critical, particularly in the current low interest rate environment. It is important to remember that unlike the equity markets, most bonds are not traded on a consolidated exchange with a best bid and offer system. Bond markets function in an over-the-counter, dealer to dealer marketplace. Inexperienced bond investors are often at a disadvantage by not having access to multiple bid and ask prices at the same time. Simply stated, investors are often unaware of the actual spread and mark-ups they are paying.
Our execution capabilities rely upon decades of extensive professional trading experience. Methodologies we employ in an attempt to enhance returns through better execution:
- We rely on a relative value approach within and across product sectors.
- We exhibit patience in an attempt to purchase securities on the bid-side of the market
- We monitor dealer inventories and product flows in order to assess the impact of supply/demand upon spreads and prices.
- Experience allows us to identify and take advantage of short-term pricing dislocations
- We will aggregate as feasible odd lot holdings (bought cheaper) into larger positions, in order to exploit the pricing differential between the odd-lot and round-lot markets.
- We leverage our years of experience and extensive network of dealer relationships to negotiate better prices for our clients.