August Quarterly Asset Allocation

August Quarterly Asset Allocation

Quarterly Asset Allocation Update

August 2012

  • In recent weeks we have participated in a number of discussions about the importance of having a clearly articulated investment philosophy, and so we thought it would be useful to start off by restating the philosophy that guides our management of your portfolio.
  • Forecasting over long periods is consistently more reliable than doing so over shorter times; hence we develop ten year forecasts for each asset class, as outlined to you each Quarter.
  • We compare forecast returns to a risk free return, being 5 year term deposits. Where long term expected returns are lower than the risk free return we deem that investment to be expensive.
  • When an asset class starts to look expensive, the likelihood is that it will become much more expensive before eventually correcting. Whilst these bubbles can be identified, what is very difficult to determine is for how long the bubble inflates before popping.
  • It is one thing to own an asset that has become overpriced if you bought it cheaply; it is another thing entirely to buy into an overpriced asset. We do not buy into overpriced assets, and we treat investors individually based on their own portfolio holdings.
  • We are prepared to go to 100% underweight, or 0% exposure to very expensive investments.
  • Portfolio risk is often expressed as volatility of returns, and we do target low volatility, but ultimately the portfolio objective is to meet your cashflow needs. This is a central consideration in managing your portfolio and means we strive to provide steady and consistent returns.
  • Finally, active security selection or ‘stock picking’ doesn’t reliably beat the returns from benchmark indices after fees and tax.
In support of the last point, we have just received figures to June 2012 from S&P Dow Jones in their Index vs Active Funds Scorecard(1) which reports on the percentage of active managers whose performance was inferior to the index return.
The exception in the table above is Australian Equity – Small Cap, where almost four out of five managers are able to outperform the index. However, the reverse is true for the other four major asset classes regardless of whether the evaluation period is short term or long term. The percentage of active managers that aren’t able to beat their benchmark index ranges from 65% to as high as 100%.
Exchange Traded Funds (ETFs) allow us to reflect long term asset allocation decisions consistent with the philosophy outlined above, in an efficient and transparent manner whilst ensuring your portfolio is well diversified within the target asset classes, including our sector and regional preferences.


This asset class remains the only one of the Risk asset classes where we have an overweight target, though we have wound in that overweight target slightly from +50% of Neutral to +40% of Neutral. The revised targets for each of the Investment Programs are detailed below, and for the vast majority of portfolios this will simply mean a little less buying to do as we continue to head towards this target, as distinct from any outright selling to come back to this target.

We have maintained the preference for the Financials sector within Australian Equities, and we are approximately 10% overweight at 54% of the asset class model compared to the broader ASX200 index. Given the income and franking credits paid by the major banks, the required growth to achieve the asset class forecast return of 11.6% is quite low, and we are confident about this sector forming the foundation of the Australian Equities exposure in the portfolios. Australian companies are just about to complete their biannual reporting season, and we will provide a more expansive update in the Monthly Commentary that will be published in the first week of September.

Australian Equities No. 1 No. 2 No. 3 No. 4 No. 5
Neutral 10.00% 15.00% 20.00% 27.00% 40.00%
Target 14.00% 21.00% 28.00% 37.80% 56.00%


The benchmark for this asset class that many international managers reference is derived from the size of the share markets in countries around the world, and roughly this means that the exposure is 85% to Developed Markets (mainly Europe, Japan and North America) and only 15% to Emerging Markets (including China, Korea, India and Brazil). There is an alternative however that weights the exposure based on the size of a country’s economy rather than its share market, and in this case the spilt is about 70% to Develop Markets and 30% to Emerging Markets.

The committee has slightly reduced the underweight to this asset class from -50% to -40%, which is reflected in the table below where the target exposure is 60% of the Neutral allocation. This 60% exposure within International Equities will be invested in Asia and Emerging Markets where our forecast returns are in line with Australian Equities. As a result we are implementing a 100% underweight to developed markets, by gradually selling down long term investors and by avoiding these investments for newer portfolios.

Regular readers will know we have had a strong preference to Asia and Emerging Markets for some time, albeit up until the recent past we have also accessed these economies via companies listed in Developed Markets. This included targeted exposure to the global consumer staples and healthcare sectors, which meant investing in companies such as Johnson and Johnson, Procter and Gamble, Coca Cola and Wal-Mart. Earlier this year we started reducing this exposure for longer term portfolios, as whilst the theme was still valid, the valuations had become much less attractive compared with investing directly in Asia and Merging Markets.

Our International Equities portfolio is now comprised of ETFs that track two indices, the S&P Asia 50 ETF (IAA) and the MSCI Emerging Markets ETF (IEM). Together they provide exposure to nearly 900 companies including Samsung, Hyundai and China Mobile. The combined country exposure of these two ETFs is to China and Hong Kong (34%), South Korea (27%), Taiwan (15%), Singapore (7%) and Latin America (6%).
International Equities No. 1 No. 2 No. 3 No. 4 No. 5
Neutral 5.00% 10.00% 15.00% 23.00% 35.00%
Target 3.00% 6.00% 9.00% 13.80% 21.00%



We have not changed our stance from the last quarterly update, and remain un-invested in the listed property asset class. For most of the last year or so our valuation of this asset class has been in the fully priced range, which means we are only expecting to get a very modest return in excess of the risk free return. At this stage we remain of the view that there is no compelling reason to reestablish positions here, though we continue to regularly monitor the sector.

Listed Property No. 1 No. 2 No. 3 No. 4 No. 5
Neutral 5.00% 5.00% 10.00% 10.00% 10.00%
Target 0.00% 0.00% 0.00% 0.00% 0.00%



The target asset allocation of 25% underweight to this sector has been maintained and we have elected to retain the composition of the model portfolio, despite a number of new investments that have come to market. In the past we have observed that when there are a large number of new issues that often existing investments are sold down, and better value and long term returns are on offer in these investments. We will monitor the new issues closely as they list on the ASX in the next few weeks, particularly for any that trade below their par value, however we are comfortable with the compilation and the long term expected returns2 of 9.9% from this asset class for the time being.

HY Income Secs No. 1 No. 2 No. 3 No. 4 No. 5
Neutral 10.00% 15.00% 15.00% 15.00% 10.00%
Target 7.50% 11.25% 11.25% 11.25% 7.50%


Last week the new investment from Westpac Bank listed (WBCHA), and it continues to trade at just slightly above its par value of $100. This is a good indication that the market accepts the income return on offer as a fair reflection for the risks that investors assume. The portfolio now has 40% exposure to these types of investments (subordinated notes), along with another 40% in the even more defensive Commonwealth Bank bond (CBAHA) and the High Interest Cash ETF (AAA).

The target portfolio is now significantly more defensive than was the case a year ago, and we continue to avoid government and semi-government bonds where interest rates are at historically very low levels. Over our ten year forecast period, we believe the best case scenario for investors in government bonds is that interest rates stay low for that entire period, and even then the return will be low. The current returns (yield to maturity) on Australian Government Bond ETFs are below 3%, and they carry the potential for capital losses should interest rates rise from these very low levels.

We will continue to source exposure for this asset class from the liquid ASX listed income securities of the major Australian banks, including diversification both between the investment structure and the issuing bank. Current return expectations are just under 6% for the model portfolio.

Income Securities No. 1 No. 2 No. 3 No. 4 No. 5
Neutral 40.00% 40.00% 30.00% 20.00% 0.00%
Target 55.50% 49.40% 41.40% 29.72% 12.40%


In the next month we may well get some clarity as to the future actions of the European Central Bank and the US Federal Reserve, and these decisions remain the focus of investors in the short term. We will continue to focus on the long term and keep you informed of our decisions along the way.

DISCLAIMER: The information in this commentary has been provided for publication by Implemented Portfolios (ABN 36 141 881 147. AFSL Number 345143). The information has not been verified by Implemented Portfolios or Adapt Wealth Management Pty Ltd (ABN 76 821 231 362 Corporate Authorised Representative of CHPW Financial Pty Ltd AFSL 280201) but is believed to have come from reliable sources as noted in the acknowledgements. No Liability is accepted by Implemented Portfolios, or Adapt Wealth Management Pty Ltd, its Directors, officers, employees or contractors for any inaccurate or incorrect information. The information is a broad commentary and there is no intention that a client should act on the information without seeking professional assistance from their own advisers (legal, tax, accounting, financial planning) for suitability in respect of their unique circumstances.

About Reuben Zelwer


Reuben Zelwer established Adapt Wealth Management in 2011 to help time poor clients achieve financial freedom. For over 15 years, Reuben has helped professionals, executives, business owner and those approaching retirement make the most of their circumstances by making good financial decisions. Reuben’s professional practice is complemented by substantial voluntary work, which has included setting up financial literacy and savings programs in the local community.