Overview – A good year for the Roses

The rollercoaster performance of markets was a baptism of fire for the Model Portfolios we were actively running over the last year and a strong challenge to the concept of Dynamic Asset Allocation (DAA). However, the encouraging news is that they all came through admirably. To summarise, the concept of the DAA process is to allow for rebalancing between underlying components of a Portfolio according to a systematic risk score, where risk is defined as the balance of risk and return on the basis of something either continuing in its current direction (momentum) or reverting to some kind of trend (mean reversion). Thus having first defined a group of underlying ETFs to capture our Investment strategy (Bonds, Global Equity Factors or Global Thematic Growth) we use DAA to set out our weightings.

The variants we run as Model Portfolios are unconstrained, which means that should the risk scores become too high across most underlying components we have the ability to go into cash. This doesn’t happen that often, but when it does it can add dramatically to relative performance, both in terms of limiting downside and thus protecting capital and also in significantly reducing volatility. Of course 2020 was just such a year, leaving all our portfolios beating their benchmarks both in terms of risk and return by a handsome – in some cases substantial – margin.

Core Global Bonds

The Global Bond Portfolio returned 12.82% over 2020, compared with 9.2% for the benchmark. The one day dramatic spike in the US bond markets at the end of March created a one off spike in volatility sufficient to distort the annual volatility level to 12.3%, versus 5.6% for the All Aggregates benchmark (that wasn’t affected on that day). We would in any event expect volatility to be higher than the benchmark – at 6-7% and note that actually in Q3 and Q4 it was actually below this at 3-4%.

Core Global Bond Model Portfolio 2020: Summary Table

Core Global Bond Model Portfolio 2020: Performance

Core Global Bond Model Portfolio 2020: Performance and Contribution by Quarter

Breaking things down by quarter, we can see that the first quarter saw most of the bond ETFs deliver a negative performance, with the worst from High Yield – albeit that had the lowest average weight in the portfolio over the period. The exception of course was the US Long Bond, where we had most of our exposure and which had an extremely strong first quarter, allowing the Portfolio to return 4% for the quarter versus a little under -1% for the Global Aggregate Benchmark.

The second quarter was dominated by the spill over from the extreme volatility right at the end of the first quarter when the Fed intervened to support the High Yield Market. This meant that both high yield and Investment Grade had a very strong quarter – albeit mostly in the first few days. As a result of being underweight these areas due to high risk at the end of the previous quarter, our risk tools did not capture this short term bounce and while we did capture some of the subsequent upside, the overall portfolio return was dragged down by the long bond exposure, leaving a return of 3% for q2, just behind the 3.1% for the benchmark.

For q3 and q4 the story was essentially one of reducing exposure to the long bond and increasing exposure to corporate bonds in the Investment Grade and high yield sectors.

Core Global Equity Factor

Core Global Equity Factor Model Portfolio 2020 Performance

Our Global Equity Factor Model Portfolio had a strong last quarter to the year and ended up with a return for the year of 21.2%, compared with our Global Equity Benchmark of 15.9%. To a large extent this annual excess performance reflected the effectiveness of the DAA process in the first quarter, when the discipline of the Risk Matrix process meant that the model fell only 7% while the index fell by 21%. It also shows up as a considerably lower level of volatility (albeit still much higher than ‘normal’) for the year as a whole, where the model portfolio volatility was 17% versus 29% for the benchmark. Overall this gave a Sharpe Ratio – which combines return and volatility and is a widely used measure of portfolio ‘success’ – of around 1.3, versus 0.7 for the benchmark.

Core Global Equity Factor Model Portfolio 2020: Summary Table

Core Global Equity Factor Model Portfolio 2020: Performance and Contribution by Quarter

Looking at the performance by quarter, we can see that in the first quarter when the benchmark fell over 20%, the Global Equity Factor Model Portfolio was only down 7%, mainly down to a timely move into cash in early to mid February. During the second quarter the Portfolio rebounded – albeit less than the benchmark, but that simply reflected its lower downside in q1. The cash was redeployed and while the momentum ETF had the biggest weight and the best performance the (lower) weighting in value still acted as a drag on overall portfolio performance as the overall factor was negative. The same factor had a similar 1% drag on performance in q3, but in q4 significantly outperformed Momentum. The worst performer in the fourth quarter was min volatility which was essentially flat. However, size, which was our biggest factor, was the best performer in q4, leading to a 11.4% performance overall.

Core Balanced Portfolios

Core Global Balanced Model Portfolio 2020: Performance

As a combination of the Equity and Bond Portfolios we would expect the balanced portfolios to reflect their relative Alpha against their benchmarks and as such we see the balanced 70:30 fund delivers 19% versus 15.3% for the benchmark, with volatility of around 12.7% versus 19.8% for the benchmark. As with the underlying funds, this lower volatility was largely a function of the ability to be out of equities in mid Q1 before returning in later q2. Encouragingly for investors looking for a core portfolio solution the Sharpe Ratio on this model portfolio sits at 1.54, 1.14 and 1,46 respectively for 1, 3 and 5 years, while the benchmark for all three years is below 1.

Core Global Balanced Model Portfolio 2020: Summary Table

Core Global Equity Thematic Growth Portfolio

Core Global Equity Thematic Growth Model Portfolio 2020: Performance

The Core Global Equity Thematic Growth component ETFs all have an exposure to growth and are thus ‘higher risk’ than the Core Global Equity Factor portfolio.  As such they have had an extremely powerful q4, returning over 20%, with a total return for the year of 52% dwarfing that of the Global Benchmark at 15.9%. In terms of volatility, the risk models reduced exposure in Q1 and limited downside, but allowed for more upside exposure for the second half. As such overall volatility, at 17% was higher than normal, albeit very similar to the Core Equity Factor Model, but still way below the 28.6% recorded by the benchmark. Not surprisingly 1 year Sharpe Ratio was very high, at 3.55 versus 0.7 for the benchmark. Three and five year Sharpe Ratios of 1.9 and 2.0 were also very pleasing.

Core Global Equity Thematic Growth Model Portfolio 2020: Summary Table

Core Global Equity Thematic Growth Model Portfolio 2020: Performance and Contribution by Quarter

It is instructive to break things down by quarter – especially given the ‘unusual’ nature of 2020. In the first quarter, the Core Global Equity Thematic Growth portfolio fell 9% overall. The biggest drop in absolute terms was for Robotics and Automation ETF, but that had a lower overall portfolio weight than say, the Global Clean energy ETF, which even though it fell ‘only’ 7.2% was the biggest contributor (price move multiplied by weight in portfolio). The heavy weighting in both Gold, and particularly cash, towards the end of the quarter as risk deteriorated was obviously a major factor in helping the portfolio overall beat the benchmark of Global Equities, which by contrast fell much more heavily, dropping by 23%.

For the second quarter, as the risk started to unwind somewhat, the Dynamic Asset Allocation moved the Portfolio out of cash and back into the ETFs, but with a stronger slant towards both Gold and Digital Healthcare, which accordingly were the biggest contributors to return. Robotics and Digitalisation were among the strongest performers in absolute terms and the fund did increasingly move into those areas, making them the next largest contributors. Overall for the quarter the portfolio returned a very healthy 18%, compared to the benchmark of 24.8%, but then the benchmark was recovering from a very weak q1. So overall for the first half, the Model Portfolio delivered +7.5% versus the benchmark of -5.1%

By the third quarter the fund no longer had any cash and was fairly evenly distributed across all the themes, with the biggest weight in Healthcare innovation, which was the second strongest performer in absolute terms and also overweight in the Global Clean energy ETF, which had an astonishingly strong quarter, up over 45%. This helped the overall portfolio to a return for the third quarter of just over 14%, versus the MSCI World benchmark of 8.2%

As we went into the final quarter we had steadily reduced our weight in the Gold ETF (although it picked up a little towards the end of the quarter) while remaining almost equally weighted across the other themes. Once again, the Global Clean Energy ETF did extremely well, followed by both the Robotics and Automation and the Healthcare innovation – both in terms of absolute performance and overall contribution to return. Total return for the Portfolio was thus just under 22% for the quarter versus 13.4% for the benchmark.

Overall then, the performance might best be summarized as a relative lack of drawdown in Q1, helped by a move into cash and gold, followed by a robust recovery in Q2, led first by Gold and Innovative Healthcare and then for the second half by Robotics, Digitalisation and, particularly, Global Clean Energy.

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