Valuation in certain asset classes has recently become a more important factor in how we allocate assets.
In the current climate, we are concentrating on the fixed-interest sector in particular. Hence, in order to clarify our positioning, we continue to have a pro-risk bias, but this is increasingly focused on equity risk, where we are overweight across portfolios. We remain underweight in both government bonds and cash, and have recently started to remove the long-standing overweight in corporate bonds.
In such a low-yield environment, we can be less dependent on market returns (beta) to deliver in sovereign and corporate bonds. That fact leads us to evaluate how much risk we allocate towards manager skill (alpha) to add value through active decision-making.
Within corporate bonds, there are a number of strategies that differ in the degree to which they are driven by market and active returns. At one extreme, we have passive products, followed by traditional ‘index plus’ funds, through to strategic bond funds, and total return and absolute return strategies. Sovereign bonds also have a similar suite of options.
When valuations become extreme, as is now the case within fixed interest, we need to seek opportunities to expand our exposure to those funds that operate within more flexible boundaries, but only if the reward compensates for the risk taken.
We have recently reduced exposure in government and corporate bonds, however in both asset classes we have been redistributing this exposure towards more actively managed strategies.
We are also including holdings that are more focused on total return, where managers have flexibility with regard to capital structure, duration, geography, and currency positioning.
With valuations being so compressed, the potential to incorporate more genuine absolute return strategies where market exposure can be completely removed is another area of focus and future discussion.
Toby Vaughan is senior fund manager at Santander Asset Management UK
