By Jayson Forrest - Managing Editor - IMAP Perspectives
Alex Ventelon and Wayne Chatterjee (Morgan Stanley) explain why taking a multi-asset allocation approach is better suited to generate favourable risk-adjusted returns in the current volatile and inflationary environment.
In today’s inflationary environment, why should advisers consider a multi-asset allocation approach to portfolio construction? For Alex Ventelon - Head of Research and Investment Strategy at Morgan Stanley Wealth Management Australia - it’s a no-brainer, as inflation will remain high and continue to erode savings.
Speaking at the 2022 IMAP Advice in Action Conference, Alex says with cash rates falling to near zero in the last couple of years, real returns on cash have been negative in four of the last five years.
“Morgan Stanley expects headline inflation in Australia to be strong this year (4.6 per cent) and in 2023 (3.1 per cent). Cash rates will move higher but not enough to match inflation, so we expect substantial negative real returns for 2022 and slightly negative returns for 2023,” he says.
But despite the current inflationary environment, Alex says it’s important for clients to remain invested in the market. He believes the best way to remain invested is through a multi-asset allocation, which provides diversification, with the “added benefit of a multi-asset ‘growth’ allocation historically generating a better return for lower risk, compared to a 100 per cent Australian equities portfolio”.
“Even in a set-and-forget SAA setting that holds 90 per cent equities and 10 per cent in bonds and cash, the investor will receive better returns and lower volatility than being fully invested in Australian equities,” says Alex. “So, there is an inherent benefit to being invested in multi-asset portfolios across various asset classes.”
Alex Ventelon - Morgan Stanley
Wayne Chatterjee - Morgan Stanley Wealth Management Australia
We don’t have a set view about active versus passive in a multi-asset portfolio. Instead, we have a combined approach because we believe there is no asset class that is inherently better for active managers or for passive investing. It’s all about assessing the market phase
Four pillar investment process
According to Brent Finneran - Vice President, Head of Distribution at Morgan Stanley Wealth Management Australia - the investment process at Morgan Stanley is built on four pillars: asset allocation, selection between active and passive management, manager selection, and portfolio construction and risk management.
He explains: “We start with asset allocation, where a strategic blend of assets are used to align with the client goals. From there we move to our second pillar, which is to determine the correct blend of active and passive management. The right mix of active and passive investment styles optimises fees and may beat single style strategies.
“Our third pillar is manager selection. Our manager selection process ensures managers meet Morgan Stanley’s quality standards. And our final pillar of the investment process is portfolio construction and risk management. This is where Morgan Stanley seeks to manage risk efficiently by combining and weighting managers.”
Brent adds that with each pillar, Morgan Stanley is trying to add value in its investment process.
“For example, we don’t have a set view about active versus passive in a multi-asset portfolio. Instead, we have a combined approach because we believe there is no asset class that is inherently better for active managers or for passive investing. It’s all about assessing the market phase.”
However, Alex believes asset allocation is where advisers can provide the most value to their clients.
“Asset allocation is a two step process, where SAA sets the ‘trajectory’ to achieve financial goals, and Tactical Asset Allocation (TAA) seizes opportunities with the objective of reaching those goals faster and/or exceeding peers,” he says.
According to Alex, SAA is the main component of asset allocation and will drive 90 per cent of a portfolio’s outcome over the long-term. Morgan Stanley sets its Capital Market Assumptions with a seven year outlook and this is adjusted infrequently, while TAA looks at short-term opportunities within asset classes to add additional value above the rest of the market. TAA positioning at Morgan Stanley is reviewed every 4-6 weeks, with weekly Investment Committee monitoring that leverages the best ideas from Morgan Stanley Research.
Asset allocation is a two step process, where SAA sets the ‘trajectory’ to achieve financial goals, and TAA seizes opportunities with the objective of reaching those goals faster and/or exceeding peers
Current views on TAA
When looking at the current market outlook, Morgan Stanley remains somewhat bearish in its view. Global equities are in the midst of a bear market that is not yet finished, and earnings revisions are slowing globally. Cost pressures also remain an issue for corporates around the world.
“And at the same time, the Federal Reserve has embarked on an aggressive monetary policy tightening path in an effort to fight inflation that is running at a 40-year high in the U.S.,” says Brent.
However, despite market volatility and the current inflationary environment, Morgan Stanley believes there are still opportunities for investors in various asset classes. These include:
International Equities: Morgan Stanley favours defensive sectors with minimum volatility (healthcare and infrastructure), combined with inflation hedges (materials and energy) and exposure to higher yields (value).
Australian Equities: This market looks more attractive in the current environment, given its recent de-rating and defensive quality attributes. Both the energy and materials sectors are attractive with their low earnings multiples, favourable free cashflow, and the positive outlook for commodities. Morgan Stanley also likes stable earnings/high dividend quality stocks.
Fixed Income: Morgan Stanley prefers Australian short-term credit after the recent rise in yields. It believes short-term yields will come in as interest rate pricing is too aggressive. It also likes floating rate Investment Grade markets to capitalise on rising rates.
Commodities: Fundamentals remain strong in most key markets, benefiting from supply/demand imbalances. Commodities offer a solid hedge against inflation and geopolitical risks. Morgan Stanley likes aluminium, iron ore and oil.
Alternatives: The manager favours hedge fund strategies that have the ability to go long and short (e.g. relative value, long short and market neutral).
However, despite our views on TAA and portfolio positioning, at this point in time, we are not forecasting a recession. Notwithstanding the current Ukraine/Russia conflict and supply chain issues with China, our view is that the 10-year outlook for capital markets and multi-asset portfolios is positive
Portfolio positioning
In terms of portfolio positioning, overall, Morgan Stanley remains tactically more defensive.
For equities, its recommended positioning for Australian investors is neutral/mild underweight. According to Alex, Morgan Stanley favours defensive exposures (minimum volatility, infrastructure), with value still preferred over growth.
“Australia remains preferred in the current environment, given the recent de-rating, defensive quality attributes and attractive yield,” says Alex.
For fixed income, Morgan Stanley’s positioning for Australian investors is mild underweight. “In credit, we have moved our exposure to ‘higher grade’, replacing floating rate notes with cash, while we replace hybrids with subordinated debt.”
And with cash, the manager’s recommended positioning for Australian investors is mild overweight. It advises to retain a small cash allocation to deploy opportunistically.
“However, despite our views on TAA and portfolio positioning, at this point in time, we are not forecasting a recession. Notwithstanding the current Ukraine/Russia conflict and supply chain issues with China, our view is that the 10-year outlook for capital markets and multi-asset portfolios is positive,” says Alex.
About
Alex Ventelon is Head of Research and Investment Strategy at Morgan Stanley Wealth Management Australia; and Brent Finneran is Vice President - Head of Distribution at Morgan Stanley Wealth Management Australia.
They both spoke on a session titled - ‘The importance of a robust investment process’ - at the 2022 IMAP Advice in Action Conference.