You’re committed to a disciplined asset allocation strategy. Yet you also want to add alpha to your clients’ portfolios. Can you do both?
Yes, by tilting: overweighting (or underweighting) certain asset classes, geographic markets or individual stocks within a broader asset allocation.
“Tilting is meant to be either about risk management or trying to seize opportunities,” says Garnet Anderson, vice president and portfolio manager at Tacita Capital. “The degree is tied into how much confidence you have, as well as [what] degree of risk you’re willing to [accept].”
At Anderson’s firm, most tilts are between 70% and 130% of the initial target allocation: if the client’s neutral equity target is 50% of the portfolio, for example, that allocation could shift from 35% to 65%, depending on market outlook, client risk tolerance and other factors.
“Often they’ll be ranges established within [an] investment policy statement,” Anderson says.
“It’s a simple process,” says Mark Webster, vice president, BMO ETFs for Western Canada. “You can accent an index by using a sector over- or underweight. You could do this large cap versus small cap; you could do it value versus growth; you could do it on international versus domestic.
“On a portfolio level, you could do stocks versus bonds. In the bond world you could do government versus corporate.”
Tilting also requires clarity of objective. “Be selective with the tools that you implement,” he says. Those tools could include stocks and bonds, mutual funds or ETFs.
“You’ve got to be highly regimented [and] get out when the return expectation has been met,” Webster adds. “Any tilt must have objective return expectations. Failure to reduce a [tilt] once the targeted return has been met adds unnecessary additional risk to a portfolio that has achieved its short-term return target.”
To help clients decide how much to veer from current asset allocation strategies, define how much you’ll do, or how much discretion you may have, in terms of different sectors or weightings.
Within the broader allocations, the portfolio may be tilted toward income-producing assets, or away from a particular currency. Here are some tilting examples.
The basic value tilt
This popular strategy overweights value or growth opportunities, depending on the market cycle.
“More conservative investors would likely apply value tilts, maximizing yield through dividends or perhaps reducing risk through low-volatility strategies,” Webster says. “Though it’s unlikely value tilts would be removed, because yield or risk budgeting strategies reflect longer-term views of markets.” He outlines several ways to implement this strategy: by buying traditional value sectors ETFs (example: utilities and infrastructure); by choosing a value-oriented fundamental or low-volatility ETF; or by investing in dividend stocks.
The opportunistic tilt
Tilting can take advantage of market opportunities. Case in point: Anderson’s firm shifted to corporate and high-yield bonds in 2009.
With spreads over treasuries sky-high by historic norms, Anderson moved portfolios toward corporates and high-yields. “As long as we [could] be patient, and as long as the world [didn’t] come to an end, we knew [clients] would get paid handsomely,” Anderson says.
At the time, nearly all of Anderson’s clients were tilted toward corporate bonds; those with higher risk tolerances were also moved toward high-yields. Once valuations returned to normal, Tacita unwound the tilt. “That worked out well for clients for three-ish years,” he reflects.
The defensive tilt
This process can protect a portfolio against market mispricing within traditional allocations.
Anderson likes an example from several years ago: inflation-protected bonds. “Who wants to be the investor to buy a 10-year U.S. TIP bond at -0.7% yield?” Anderson asks rhetorically. Yet that’s exactly what TIPs were offering until recently.
Those who stuck to their allocation targets would be guaranteeing a loss of purchasing power over a 10-year period. Instead, Anderson moved portfolios away from the asset. “You don’t go down to zero,” he notes. “But you lighten up, and you wait until that [asset] normalizes. That could be a year away; that could be three years away.”
The income tilt
One way John Hood’s firm deals with anemic yields is to tilt portfolios toward covered-call strategies. A portfolio manager at J.C. Hood Investment Counsel, Hood says such a maneuver is applied to up to 20% of the portfolio, and is reserved primarily for older clients with larger portfolios.
Hood’s average contract tends to be six months (“That way, I’m able to get a little bit better downside protection,” he says), and he usually sells the options at the money. To compensate for the additional equity risk, Hood typically trims the client’s long-only equity portion of the portfolio.
One of Hood’s favourite strategies is to write covered calls on the Canadian banks—either on individual stocks or the indices. For smaller portfolios, Hood buys one of several covered-call ETFs.
The currency tilt
Tilts also let managers capture gains from currency fluctuations. By shifting holdings to a particular currency (or away from another), it’s possible to add portfolio alpha.
It’s a strategy Hood and his firm use. After several years of buying hedged versions of ETFs that track the S&P 500, Hood’s now shifting to unhedged versions. “I’ve been buying the XSP for years, because it’s hedged against a decline in the US dollar,” Hood says. “Well, now I’m concerned about the decline in the Canadian dollar, so my latest purchase has been [Vanguard Large-Cap ETF] VV.”
The emerging market tilt
Anderson’s firm has found attractive valuations within emerging markets, leading to a small tilt toward EM equities for the past six months, though he hasn’t overweighted them.
“Emerging markets is the cheapest region.”
He adds, “Valuation levels [have been] relatively inexpensive relative to the U.S. or Canada”—about 15% less expensive that the global equity index.
Anderson says these valuations have persisted despite a positive long-term outlook. This means a shift should reward investors who can wait while valuations normalize.
James Dolan is a Vancouver-based financial writer.