Balancing irrational market outlooks with rational data for desired client outcomes

Author Image Phil Butler Portfolio Manager, M&G Treasury and Investment Office (T&IO)
5 minutes read
Last updated on 6th Oct 2019


Phil Butler, a Portfolio Manager and CF30 at M&G T&IO, explains how the group’s internal Economic Scenario Generator assists the team in setting their long-term strategic asset allocation which is overlaid with shorter-term tactical decisions on the PruFolio Risk Managed fund range in order to produce returns that are in line with client risk appetites.

The number of multi-asset vehicles offering straightforward ‘off-the-shelf’ solutions that can manage client risk and return expectations has grown significantly over the past decade. Often, it’s the breadth of these solutions, and the fact funds are managed to specific asset allocation limits that makes them so attractive for advisers to use on behalf of clients.

The key to success in these strategies is ensuring fund managers remain focused on the fundamentals driving the investment strategy, whilst simultaneously taking into account both strategic and tactical asset allocations.

T&IO, the multi-asset fund management team at Prudential, believe the key to ensuring how they appropriately manage customers’ money across their multi-asset funds, lies in the hands of the group’s proprietary Economic Scenario Generator, known as GeneSis.

GeneSis is a top-down asset return model, which encapsulates a number of factors involved in the investment management process, including global markets, benchmarks and the historic performance of assets. The teams internally generated capital market assumptions feed

GeneSis and are the bedrock to running forward looking scenarios. The beauty of the model is that it continually takes in new data, trends and structural shifts.

"We run every single outcome that we can model for each of the risk-managed funds, look at all of the possible paths of future returns and pick the one most likely to provide optimum risk-adjusted returns"



Managing client outcomes

Phil Butler, a portfolio manager at T&IO, explains: “Once you have capital market assumptions and portfolio constraints in check, you factor in the client’s risk appetite. We run every single outcome that we can model for each of the risk managed funds. Our Long Term Investment Strategy team (LTIS) look at all of the possible paths of future returns and pick the one most likely to provide the client with the optimum risk-adjusted return. This type of portfolio modelling indicates the preferred asset classes to invest in, and what proportions, depending on the client’s risk acceptance. Our three ranges each offer five funds of an increasing risk tolerance”

The GeneSis model strengthens the team’s approach to managing volatility within the portfolios. This follows the introduction of a ‘volatility ceiling’ within the PruFolio Risk Managed Smoothed, Active, and Passive funds earlier this year: “Based on the portfolio you create, you get an expected return and expected volatility. From that you can then infer a ceiling,” Butler explains.

LTIS work with other teams in T&IO and across the M&G Group, as well as using external research, to help create the Capital Market Assumptions that underpin and feed GeneSis, which is so integral to the strategic asset allocation (SAA). The LTIS team, who are quantitative modelling experts, formulate weights for asset classes and regions to provide the underlying client with the optimum risk-return output over the long-term (defined by T&IO as 5-10 years).

Once the LTIS team has chosen the regions and asset class they wish to invest in, the Manager Oversight team, led by Ciaran Mulligan, conduct quantitative and qualitative due diligence in order to identify the best manager to achieve the desired risk-return characteristics.

After this has been decided, the portfolio manager takes over the responsibility for the day-to-day management of the fund range, as well as the tactical asset allocation process for the Active and Passive funds. These elements provide quite different market insights, and together this feeds information into the portfolios in unique ways.

“Strategic and tactical asset allocation are two investment processes that hold each other’s hands, but one refreshes more regularly than the other,” explains Butler

Alternative diversification

By using careful governance and balancing strategic and tactical asset allocation, Butler and the wider teams are able to identify value over both the long and short-term. For example, by responding quickly and adjusting portfolios to shorter term market mispricing’s where valuation anomalies arise following excessive pessimism or optimism. This is part of the investment process on the PruFolio Risk Managed range, that helps it stand out from competitors, according to Butler, especially as T&IO has brought manager selection in-house for its Active and Passive funds as part of its recent refresh. It has always been predominantly in-house for Risk Managed Smoothed. Whilst this assists in keeping fees lower across the range, it also allows the group to offer a greater level of diversification, such as the introduction of US investment grade in both the Active and Passive funds.

T&IO has a team of in-house experts responsible for investments to alternatives, investing in assets both directly and within collective investment vehicles such as investment trusts. This team’s expertise stretches across a range of assets seldom found in daily priced multi-asset funds such as hedge funds, infrastructure and private equity.

GeneSis in action

While 2018 was the first year in a decade where markets really struggled, such allocations to alternatives - particularly infrastructure, private loan debt and UK property – helped increase diversification within the fund range. Both the Risk Managed Active and Passive Funds outperformed against the peer group.

The team’s strategic asset allocation decision to reduce exposure to risk assets during the summer proved timely ahead of the sharp sell-off that took hold in October. So, a tactical call was made to add some risk back into portfolios, after their model suggested the sell-off had created valuation anomalies in certain areas. This underscores how T&IO’s tactical and strategic asset allocation processes, complement each other.

The team is aware of the potential headwinds facing markets and will continue to monitor them. They include a Chinese slowdown and the trade war, geo-political tensions, as well as the fallout from Brexit. While the portfolios are marginally long risk assets, the team will look to sell into a continued rally to return to a neutral positioning in 2019.

Labelled Under:

"Prudential" is a trading name of Prudential Distribution Limited. Prudential Distribution Limited is registered in Scotland. Registered Office at Craigforth, Stirling FK9 4UE. Registered number SC212640. Authorised and regulated by the Financial Conduct Authority. Prudential Distribution Limited is part of the same corporate group as the Prudential Assurance Company. The Prudential Assurance Company and Prudential Distribution Limited are direct/indirect subsidiaries of M&G plc, a company incorporated in the United Kingdom. These companies are not affiliated in any manner with Prudential Financial, Inc, a company whose principal place of business is in the United States of America or Prudential plc, an international group incorporated in the United Kingdom.