The next evolution of our fixed allocation portfolios

James McManus


read 5 min

We’ve recently made a number of adjustments to the strategic asset allocation that sits behind our fixed allocation portfolios. Here we explain why, and how, this will benefit our clients.  

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We first launched our fixed allocation portfolios in February 2017, offering our customers a low cost and low intervention approach to investing that focuses on observed long term relationships
between investment assets, rather than ongoing active oversight.  

The mix of investments in the portfolio reflects past market conditions, therefore the fixed allocation portfolio weighting can be seen as largely based on a historical perspective. Offsetting the risk of only using historical data to inform decision making, is the fact that the Nutmeg team review and update the fixed allocations once a year based on the addition of new data. We’ve previously described fixed allocation as a “set and forget” style, but there is real science behind how it’s set. 

What is a strategic asset allocation? 

A strategic asset allocation is a framework used by investors to determine their long-term weightings across different assets, at a respective level of risk. It could be interpreted simply as an investor’s base camp. Nutmeg’s strategic asset allocation has been designed to offer what we believe to be the optimal exposure over the long-term for our portfolios. The aim is to deliver the strong, risk adjusted, performance that will allow our customers to meet their financial goals.  

Our focus is global diversification. We offer exposure to large, mid and small cap stock markets across global developed and emerging markets, complemented with a broad range of fixed income asset classes such as government and corporate bonds. We also take informed decisions on aspects core to any investment portfolio’s foundation – aspects such as the level of home bias it should include, the approach to managing currency risk and the triggers for the portfolios rebalancing.  

Our goal is to ensure that while these portfolios have history to guide them, they remain best placed to deliver industry beating returns to customers over the long term. So, each year we review their strategic allocations to ensure they remain suitable for the long term.  

An evolution for our Strategic Asset Allocation 

As part of this year’s review, our investment team has revisited the core building blocks of our strategic asset allocation, seeking as always to re-test many of the assumptions that underpin these allocations. This review looks to ensure these remain robust in the medium term by recognising evolutions in the investment landscape. 

In that regard a key objective of this year’s review has been to establish a greater integration of environmental, social and governance (ESG) considerations within our strategic asset allocation. We are committed to recognising the importance of ESG factors in the delivery of sustainable long-term returns for our clients and to applying best practice when it comes to the integration of ESG factors within our investment decision making – we see this as core to our responsibility to act in the best interests of our customers.  

There is also an increasing body of evidence, both academic and industry driven, that supports the case for improved investor returns through the management of ESG risks and opportunities. We have long used ESG approaches in our managed investment approaches, and the performance benefits of doing so are clear to see from the track record of our socially responsible portfolios – which have consistently outperformed the average wealth manager since inception.  

At its core, ESG analysis is not simply related to improving the environmental characteristics of an investment, but rather about incorporating non-financial data sets alongside traditional financial data to better inform investment decision making. This means identifying new growth sectors in the economy while also avoiding industry models that will be left behind. That helps explain why the global socially responsible index has performed in excess of the global stock market.  

performance

So, we believe the time is right to make a more material change and we have sought to identify how our strategic allocations can be best adjusted to offer a material improvement in ESG characteristics while limiting the trade-offs in terms of additional risk or cost for investors, and crucially recognising the long term environmental, social and governance risks financial assets face. Risks such as climate change, policy evolutions and demographical shifts.  

Our goal is to ensure our portfolios remain best placed to deliver industry beating returns for our clients in the years ahead, given our belief that deeper ESG integration can improve the long-term risk and reward characteristics of our portfolios.  

What does ESG integration mean? 

In simple terms, ESG integration is focused on recognising material environmental, social and governance issues within an investment portfolio. However, ESG integration is far from straight forward and is very much specific to how an investor frames materiality. It doesn’t simply mean excluding certain assets or sectors from portfolios. Integration focuses on the analysis of the key ESG issues that represent material financial risks and the optimal way to address these while balancing other considerations such as risk and cost.  

Viewed through another lens, materiality could also be defined as the investment assets that have the most impact on our client’s long-term risk and return. That would naturally favour an approach to ESG integration that centred on the assets which, on average, drive the majority of portfolio risk (either due to their relative risk or absolute level of allocation). The prevalence of greater and more reliable historical ESG data sets for equity investing, in comparison to the relatively nascent market for fixed income assets, also supports an equity centric approach to ESG integration in portfolios. 

So, in order to improve their longterm risk reward profile, we have recently made an adjustment to our fixed allocation portfolios in order to incorporate a number of funds that offer greater ESG integration.  

This means we will be altering the portfolios’ exposure in large and medium sized developed market and emerging market stocks, allocating a portion of this exposure to strategies that focus on companies with outstanding ESG ratings and excluding companies whose products have negative social or environmental impacts. That portion has been carefully calibrated to ensure that we are materially improving the ESG alignment of portfolios, while at the same time controlling risk and cost implications.  

What do we mean by material? For a medium risk portfolio, these changes result in a reduction in the carbon intensity of the portfolio of -7.8%, alongside a -23% reduction in the number of companies in violation of UN Global compact principles, and further reductions in the percentage of portfolio holdings that are in violation of human rights norms, or involved in significant controversies. The table below demonstrates how the new allocation compares to the old, across a range of ESG metrics. 

metrics 

What other changes are you making to portfolios? 

As previously noted, we review the weightings of our fixed allocation portfolios annually to ensure they remain best placed to deliver performance in the long term.  

Alongside the changes in integrating ESG focused holdings, our investment team has also made some further tweaks to the currency and country exposures of portfolios, in-line with our focus on ensuring portfolios remain suitable to deliver optimal returns over the long term.  

You can discover more about how our team design our strategic asset allocation and how we approach topics such as currency risk and UK home bias in investment philosophy available here.

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Risk warning: As with all investing, your capital is at risk. The value of your portfolio with Nutmeg can go down as well as up and you may get back less than you invest. Past performance is not a reliable indicator of future performance. Forecasts are not a reliable indicator of future performance. 

 

 

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James McManus
James is chief investment officer at Nutmeg, having joined in 2015 from Coutts & Co. A self-confessed ETF geek, James is regularly quoted in the national and industry press and has been voted one of Private Asset Manager’s ‘Top 40 under 40’ in each of the last three years. James holds a BSc in International Business from Nottingham Business School, the CFA UK Investment Management Certificate, and the CFA Certificate in ESG Investing. He can be found tweeting @j_a_mcmanus

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