Structuring the growth part of the portfolio

By Jayson Forrest

With market volatility easing and inflation receding, it’s an ideal time to re-evaluate portfolios. Victor Huang (Milliman), Geoff Greetham (Accordius) and Dermot Ryan (Renaissance Asset Management) explore some of the key elements that should be considered when structuring the growth part of a portfolio.

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Having recently come through a tumultuous investment period, largely due to COVID, it’s unsurprising that the last couple of years have been reasonably lacklustre for Australian growth. However, now, 18 months into an interest rate hike cycle, inflation is finally beginning to recede, making it an ideal time for advisers to consider where they are positioning their portfolios for growth.  

“As inflation peaks and interest rate hikes stop, that opens up good opportunities for a number of assets,” says Dermot Ryan — Portfolio Manager at Renaissance Asset Management. He points to small cap equities, which didn’t perform well during the recent period of high inflation, underperforming by about 25 per cent over this period. However, with inflation peaking and now receding, he says the two-year forward growth estimates for small caps are up to double that of large caps.

Speaking at the 2023 IMAP Independent Thought Conference in Melbourne, Dermot believes small caps provide investors with some interesting opportunities for the growth part of their portfolio. “The real benefit of small caps is their rebound potential. The ASX Small Ords is currently trading at roughly the same level it was in 2018 and is 25 per cent lower than its all-time high set in 2021, whereas the ASX 100 is at or near all-time highs. Traditionally, small caps have been strong in the recovery phase of the market, which we believe makes these stocks very attractive.”

And Dermot believes there are investment opportunities not just in Aussie equities, but across many asset classes, like emerging market debt and global equities, which investors can take advantage of.

It’s a view supported by Geoff Greetham — Executive Director at Accordius — who believes that although the general economic environment remains uncertain, with interest rates likely to stay elevated over the short-term and finance becoming scarcer, there are more opportunities cropping up in the market for investors.

“Over the last couple of years, if you have wanted to keep up with inflation and achieve after-tax returns, it has necessitated taking on more risk in your portfolio,” says Geoff. “That’s because over the last couple of years, the classic 60/40 portfolio failed, as both shares and bonds dropped together.

“But we now have risk-free rates back at 4 per cent, so the classic 60/40 growth/defensive allocation is relevant again and offers investors some protection. Investors can be confident that if equity prices do head south, they now have some protection on the bond side of the portfolio for the first time in a while.”

Like Dermot, Geoff believes there are opportunities to maximise the growth part of the portfolio by turning to asset classes like small caps, which he expects should have a favourable environment going forward, as inflation and interest rates start to come down.

“As well as small caps, we’re increasingly looking to broaden the growth opportunities of our portfolios into areas like senior secured loans or distressed debt. Those are the sorts of areas that we’re keen to explore.”

Dermot Ryan — Portfolio Manager at Renaissance Asset Management
Dermot Ryan - Renaissance Asset Management
Geoff Greetham is Executive Director at Accordius
Geoff Greetham - Accordius
 Victor Huang is Principal and Head of Investment Solutions Asia-Pacific at Milliman
Victor Huang - Milliman

The real benefit of small caps is their rebound potential. The ASX Small Ords is currently trading at roughly the same level it was in 2018 and is 25 per cent lower than its all-time high set in 2021, whereas the ASX 100 is at or near all-time highs. Traditionally, small caps have been strong in the recovery phase of the market, which we believe makes these stocks very attractive

Dermot Ryan

The markets are pricing in a very muted level of volatility for equities over the next six months. And although this volatility is likely to ramp up by Q2 or Q3 next year, it means that for the risk management strategies we manage, we’re currently quite strongly allocated to equities because of where we see volatility in the market over the short-term.”

Victor Huang

Low volatility environment

When it comes to structuring the growth part of a portfolio, as a global actuarial management consultancy business, Milliman puts a lot of focus on what the markets are pricing in, as well as market expectations.

So, despite inflation still being high, as well as the probability of a U.S. recession remaining around 60 per cent and Australia at just under 50 per cent, and a significant shake-up of the property market in China (which potentially could lead to a sizeable slowdown in growth and deflation for China), Victor Huang — Principal and Head of Investment Solutions Asia-Pacific at Milliman — remains bullish, pointing to the VIX index and option markets which remain quite optimistic.

“The markets are pricing in a very muted level of volatility for equities over the next six months,” says Victor. “And although this volatility is likely to ramp up by Q2 or Q3 next year, it means that for the risk management strategies we manage, we’re currently quite strongly allocated to equities because of where we see volatility in the market over the short-term.”

With the current low volatility environment, Victor believes there are a number of opportunities for investors to add to the growth part of their portfolios. However, he cautions: “From an investment perspective, if we put on any form of hedging strategy, it’s important that clients understand what the objectives of the strategy are and they have a good understanding of how that strategy is expected to perform in different parts of the market environment.”  

Victor says that with any form of risk management strategy, it’s important for the strategy to be dynamic, enabling you to dial up and down your exposures relatively quickly.

“For example, right now, while we view risk volatility in the market as being relatively low, the benefit of using derivatives allows us to manage risk and implement changes quickly,” he says. “With these types of strategies, it’s all about how you implement them and being able to react to different types of environments very quickly.” 

The traditional 60/40 portfolio is again of interest for many clients. And with our younger/middle aged clients who have time on their side, we’re talking to them about broadening their growth assets to cover more diverse opportunities, like senior private loans and distressed debt. That’s because these younger clients are better able to cope with illiquidity for a period of time

Geoff Greetham

Growth assets

But for long-term investors — whether accumulators or retirees — Milliman believes a large portion of assets should remain in growth, such as Aussie and global equities. Victor says investors need exposure to growth assets to combat inflation.

“The caveat here is that pre-retiree and retiree investors are more exposed to sequencing risk. So, while it’s important to have exposure to growth assets, you also need to be able to manage the risk of that exposure as well.”

Dermot believes that despite much of the performance in the market being dominated by top 50 stocks, there remains a lot of opportunity and capacity in the small caps sector, which he says offers significant growth and valuation appeal to investors.

However, when it comes to global shares as part a diversified portfolio, he says advisers need to carefully pick their region, rather than be dominated by U.S. stocks. “You need to be careful where you pick your regional allocations, otherwise you’re just buying the MSCI World.”  

Whether accumulator or retiree, Geoff agrees it is essential that advisers understand their client’s investment timeframe, risk profile and investment preferences, like ESG and impact investing. 

“The traditional 60/40 portfolio is again of interest for many clients. And with our younger/middle aged clients who have time on their side, we’re talking to them about broadening their growth assets to cover more diverse opportunities, like senior private loans and distressed debt. That’s because these younger clients are better able to cope with illiquidity for a period of time.”

Right now, while we view risk volatility in the market as being relatively low, the benefit of using derivatives allows us to manage risk and implement changes quickly. With these types of strategies, it’s all about how you implement them and being able to react to different types of environments very quickly

Victor Huang

A role for property

Although not traditionally considered a defensive asset, David accepts there is a role for property as a defensive play within a portfolio. He believes property, particularly premium commercial property, does provide some defensive characteristics and interesting opportunities in a diversified portfolio.

At Atrium, property falls into the manager’s ‘diversification’ bucket. However, Brendan cautions that with property: you need to understand the verticals you’re looking at; what type of risks you’re taking in that part of the portfolio; and whether they are correlated to other risks you already have in parts of your portfolio.

“For this reason, we’ve been avoiding commercial/office for a while in our real estate portfolio. There are also liquidity issues to be aware of. You want to make sure that the structures you’re going into have liquidity that match the liquidity of the underlying assets,” he says.

However, Michael doesn’t believe property can be considered a defensive asset.

“If you’re structuring the defensive part of a portfolio, there are many more defensive assets you can include — like cash, bank bills, investment grade credit, and government bonds. You can blend these together in a diversified portfolio to provide the defensive part of the portfolio,” he says

About

Victor Huang is Principal and Head of Investment Solutions Asia-Pacific at Milliman, and

Geoff Greetham is Executive Director at Accordius.

They spoke on ‘Structuring the growth part of the portfolio’ at the 2023 IMAP Independent Thought Conference.

The session was moderated by Dermot Ryan — Portfolio Manager at Renaissance Asset Management.

 

 

 

 

 

 

 

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