WHEB Commentary

George Latham

Strategic Asset Allocation to Future Proof a Portfolio


Traditionally Asset Allocation has meant choosing between a rigid set of definitions of different Asset Classes for investments: Equities, Bonds, Property, Cash, or geographic allocation between different currency blocks. The determinants of allocation between these categories often boil down to little more than interest rate expectations. At WHEB we believe there is likely to be so much change to the landscape for the economy and wider society over the coming decades, that there is a need for another dimension to the allocation decision – namely to understand which part of the economy an investment portfolio should be exposed to.

We live in a rapidly and profoundly changing world. Challenges created by Resource Scarcity, Urbanisation, Globalisation and Ageing Populations will act as a significant constraint on ‘business as usual’. The World Economic Forum estimates that the same urban ‘capacity’ – including housing, infrastructure and facilities – will need to be built in the next 40 years as has previously been built in the preceding 4,000 years in order to meet projected demand. Despite falling birth rates world population is expected to reach 9 billion people by 2050, driven by the steady aging of the population. Most of this population growth continues in the developing world, which at the same time is seeing increasing numbers move out of poverty, the so-called ‘emerging middle-class’, who aspire to consume more in an increasingly resource-constrained world, or as Mayor Bloomberg pithily remarked just want “water that isn’t yellow, traffic that moves and air that you can’t see.”

Such challenges present significant risks to much of the traditional economy which forms the principle exposures for many investors’ portfolios, regardless of which asset class they are invested in, but perhaps most visibly within equity markets. The recent “Unburnable Carbon” report released by the Carbon Tracker Initiative highlighted the risks to the world’s listed oil and gas and mining companies of massive potential write downs to reserves on the basis of existing public policy, which we highlighted in a recent blog. Put simply, if current trends persist and we see a meaningful – or indeed even partial – response from governments, consumers and markets, then some parts of the global economy will suffer, and others will benefit.

Our strategic approach is to look for solutions to these challenges, and our resulting investment universe has a number of attractive characteristics. In the same way that we expect some parts of the market to suffer from change, companies that are focused on providing solutions will see stronger, long-term growth than the market average, so the universe has strong growth characteristics. The universe is focused on companies providing solutions to sustainability challenges, so the overlap with the MSCI World Universe is around 15%. However, within that definition we find a diversity of sources of growth and exposure, and plenty of opportunity too with over 850 stocks currently identified. The different characteristics of the Health theme versus the Resource Efficiency theme, for example, have a beneficial impact on the resulting volatility of the universe. The size bias is towards mid-cap: we have a threshold of $200m for a stock to be included in the universe and >90% of the portfolio has a market cap over $1bn, to ensure that we invest in established companies with better liquidity, and not in small start-ups with fancy technology ideas. Equally, although we do have some exposure to larger companies, we tend to be very underweight in companies that have a market cap of over $20bn. We think this Mid-Cap bias creates an attractive balance of risk and growth, and tends to be under-researched relative to the mega-caps that dominate the index. The universe is Global Equities enabling us to be unconstrained by geography to pick the most attractive opportunities, but our bias is developed markets, where we tend to find higher standards of governance compared to emerging markets.

We see ourselves as long-term managers in every sense, both in the way we pick stocks within the universe to construct our portfolio (our average holding period is typically more than 3 years) and also in the long-term strategic framework that defines the universe itself. As a result our fund gives clients the ability to tilt their overall exposure towards the part of the economy that we expect to benefit should these trends persist, and away from areas that face rising risk.

 

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