[Portfolio Updates] Changes To Strategic Allocation
Given the global trends highlighted in the 2023 Q3 Market Updates, there is a need to re-evaluate the existing investment strategy and amend the strategic asset allocation accordingly to reflect the new realities. After much consideration, I’ve decided to make some amendments – specifically towards the Retail Portfolio – which will be documented in this report.
What is the “Strategic Asset Allocation”
The strategic asset allocation is the portfolio allocation that we follow in the long run as it is designed to provide us with the desired underlying exposure to the respective region, countries and industries to meet our investment objective: To capture Asia’s region's long-term economic growth and performances.
While minor deviations (±15%) are allowed – such as now – to take advantage of the market situation, eventually, the portfolio allocation will have to be rebalanced back to the strategic asset allocation when the market normalizes.
Depending on what portfolio you are currently invested in, you can skip to the relevant sections:
If you haven’t already read the market updates for Q3 2023 – please read that first as it will give you better clarity as to the motivation behind these proposed changes.
1. Retail Portfolio
1.1 Strategic Asset Allocation
To reflect the new realities, global trends and their implications on the long-term growth of Asia, I’ve decided to change the strategic asset allocation for the retail portfolio in two manners:
The first will be to increase our portfolio allocation in developed countries to reduce the impact of portfolio volatility from developing countries.
The second is the introduction of an emerging market fund (Dimensional EM Large Cap Core Equity) which seeks to complement the current Asia ex-Japan Equity to reduce the impact of portfolio volatility from China and redirect it to other emerging countries.
By doing so, the overall portfolio exposure will change accordingly to the following:
1.2 Why Dimensional EM Large Cap Fund Selected
Dimensional Emerging Market Large Cap Core Equity fund is selected for two reasons.
Firstly, on the topic of cost, while some actively managed Emerging Market funds had performed well in the 10-year range, they are often not proven of which it wouldn’t make sense to pay a premium for the management.
On the other hand, while unproven, the cost that Dimensional EM Large Cap Fund is charging is comparable if not lower than most EM indexed funds (e.g. iShares MSCI Emerging Markets ETF) and way lower as compared to the other unproven actively managed funds.
Secondly, on the topic of underlying exposure, while Dimensional EM Large Cap Core is not managed like an indexed fund, its underlying exposure fits into our investment objective while costing less than the index itself, making it the prime fund to diversify the portfolio allocation further.
While unproven (Incepted in 2017), Dimension EM Large Cap’s performance has been favourable despite deviating slightly from the benchmark.
1.3 Will It Really Make A Difference
In theory, the introduction of the EM would make our portfolio more diversified and hence lower the overall portfolio volatility and risk.
In reality, however, given the high correlation between Asia Ex Japan and Emerging Market Indexes, one may wonder if the introduction of this fund would make any difference at all moving forward.
However, upon closer inspection of the recent price performance, specifically between Schroder Asian Growth (in blue) and Dimensional EM Large Cap (in white), we are able to infer the impact of having a lower China exposure during periods of which international investors are positive or negative towards China’s allocation.
As such, all things considered, I’d reckon that the introduction of the EM fund should mitigate the volatility of the portfolio by reducing the impact of international investors’ flip-flopping attitude towards China while at the same time capitalizing on growing interest and trends in other emerging markets.
1.4 Actions to be taken
Given the proposed change in strategic asset allocation and the introduction of the Dimensional EM Large Cap Fund, there is a need to:
1) Amend the existing Dollar Cost Averaging arrangement to redistribute future monthly investment into all three funds (instead of the current two funds)
2) Split the current allocation for Schroder Asian Growth Fund with the proposed Dimensional EM Large Cap Fund
3) Re-balance the portfolio allocation to the proposed strategic asset allocation.
For now, I’ll be implementing the trades necessary to facilitate (1) & (2) around mid-October 2023 (Probably on 16/17 Oct), you’ll receive a PM from me to approve the trade when the time comes.
As for (3), the rebalancing will only be initiated when the market valuation normalizes. The rationale for this is that it does not make sense to liquidate the existing undervalued Asian funds to purchase the overvalued global funds.
When the market valuation and conditions normalize, I will then initiate the trade necessary to rebalance our overall portfolio allocation to the desired strategic asset allocation.
2. Institutional Portfolio
2.1 Strategic Asset Allocation
Despite the changes made to the retail portfolio, I’ve determined that there is no need for changes with regards to the strategic asset allocation for the Institutional Portfolio as the portfolio is already well diversified based on investment style – Value (40%) and Growth (60%) – and underlying regional/country exposure unlike that of the retail portfolio (100% Growth).
Furthermore, when we examine the underlying exposure for the growth component (isolating the value component), we will realize that the underlying country allocation is well-balanced and not particularly heavy on China which essentially is what we are trying to achieve in the retail portfolio for this round of changes.
This is largely due to the balanced underlying allocation of the Asia Equity representation – FSSA Asian Equity Plus. As such, there is no need for us to amend the existing portfolio allocation given that it is already well-balanced in both investment styles and underlying region/country allocation.
3. Frequently Asked Questions
3.1 Why is there no inclusion of bonds?
On the topic of bonds, the common question that most investors would have in their mind is: “With interest rates being where it is at, shouldn’t we include the use of bonds”
In my opinion, the use of bonds – be it short or long-duration bonds - is still not viable given that the yields are comparable to the risk-free CPF Special Account rate of 4.04%.
The inclusion of bonds will only make sense if the investment objective is to profit from a potential capital gain when the price of bonds increases as interest rates decrease. While the probability of a lower interest rate is high, it is not an area that I am looking at capitalizing on.
As such, from an income yield perspective, the CPF special account is still seen and treated as a better risk-free alternative yielding 4.04% per annum while providing tax savings benefits. I’d still prefer to use and would recommend the use of CPF Special Account as a proxy to long-term bonds and be more aggressive (100% equity) with your cash investments instead.
3.2 Can We Lower Our China Allocation Further?
I’ll answer this question in two parts – Is it possible and is it recommended?
On the topic of possibility, given the current market solutions, it is not possible to liquidate our exposure to China even further unless we construct the portfolio manually using individual country-focused funds instead of a regional fund.
However, to do so, it will require us to have a high investment budget due to the minimum monthly investment requirement of $100 per month per fund. To replicate the regional exposure while having the ability to designate the preferred allocation to China, multiple funds are necessary of which it may not be feasible.
On the topic of recommendation, while it is true that the market dynamics and attitude towards China have shifted post-COVID, it is also true that China still holds an important role in the global economy – especially in the Asia region.
To give you an analogy, not having any China exposure in an Asian fund is like not having any United States exposure in a global fund. Not only is it impractical but it is also not an accurate representation of the underlying behaviour that we are hoping to track.
At the moment, the most viable method is to introduce the emerging market fund in an attempt to reduce our portfolio allocation in China while at the same time maintaining the desired underlying exposure to Asia region’s future economic growth and performances.
Should you have any questions for me, please PM me directly.
Daniel is a Licensed Independent Financial Consultant with MAS and a Certified Financial Planner (CFP®).
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