We're Re-Optimising Your Portfolios For New Economic Conditions

Freddy Lim
Freddy Lim

Co-founder and CIO

14 August 2019

Under our investment framework, ERAA®, our technology continuously monitors economic and market data to manage each of our clients’ portfolios systematically, ensuring that asset allocations are always optimised for the given economic environment, or regime. Our investment framework, ERAA®, looks at the relative rate of change between growth and inflation to define an economic regime, then makes informed asset allocation decisions accordingly.

A key feature of ERAA® is that it keeps each individual customer’s risk profile constant throughout any economic regime by systematically changing the target asset allocation when the economy or the markets substantially change. This process of proactively determining a new asset allocation target for any given portfolio is what we call “re-optimisation”. 

Our re-optimisation feature is built to protect customers’ capital by maintaining constant risk throughout different economic and market cycles. 

US growth remains positive, while non-US economies slow down

What we’re seeing now is that the US economy and non-US economies are starting to diverge after years of solid growth, and so we’re re-optimising all of our clients’ portfolios to keep risk constant in these new economic conditions, as well as to optimise returns in the new environment.

In the US, growth is likely to be slower than the high bar we’ve witnessed in the last couple of boom years. For context, US industrial production growth peaked at 5.3% YoY in September 2018. As of June 2019, the time of the latest data released, US industrial production has slowed to an annualised growth rate of 1.3%. It’s important to note that the US economy is still growing, albeit at a slower pace. Moderated growth is not to be confused with a recession. With inflation persistently low, the US economy is still in an environment that is conducive for growth-oriented assets to perform well. 

In contrast, the global economy faces a higher level of uncertainty than the US does. Just looking at China, the Li Keqiang Index has shown that a cyclical slowdown has already begun since February 2017 when the index peaked at 12.85% YoY. Remarkably, this cyclical slowdown in the Chinese economy started roughly a year before the US-China trade war broke out. The cyclical headwinds have also reached other economies, such as the rest of the Asia ex-Japan region, and emerging markets, such as Brazil, and the Eurozone. As shown by Markit’s Eurozone Manufacturing PMI which has declined from 62 (December 2017) to 46.5 (June 2019), European manufacturing activity has been declining rapidly since December 2017 and weighed on overall economic activity.  

How does this re-optimisation change your asset allocation?

ERAA® is taking notice of the increased divergence between the US and other economies in the world, and so our system will re-optimise your portfolios to reflect the latest economic conditions around the world. In the upcoming re-optimisation, ERAA® is deploying asset allocations that maintain portfolios under a “disinflationary growth” regime for US-based assets and shifting to our “All-Weather” strategy for non-US assets. 

More specifically, what you’ll see in your updated asset allocation is that ERAA® is allocating more growth-oriented assets toward the US and invest more in protective assets when it comes to non-US markets. 

ERAA® is also allocating funds toward European equities, despite weaker economic performance in the Eurozone. This is because one of the core pillars of ERAA® is to monitor market’s valuation relative to economic fundamentals and to make valuation adjustments whenever their differences are significant. In the case of European equities, ERAA® identifies that the market has priced in a level of sentiment that is significantly more depressed than what economic numbers are suggesting. As a result, ERAA® makes an upward adjustment to the expected returns of European equities. The last time ERAA® made such a valuation adjustment was in mid December 2017 when the price of Gold was hovering around 1247. Fast forward eighteen months to today, the valuation gap for Gold has narrowed (i.e. less undervalued than before) and Gold has rallied from 1247 to around 1500. However, the valuation gap for Gold is only partially corrected and ERAA® continues to maintain significant allocation for Gold. As you can see in the Gold example, ERAA®’s valuation adjustments are medium to long-term in nature; today, the same logic applies to European equities.

Our mission to bring you the best from investing and technology

At StashAway, we are committed to continually bring you innovations when it comes to managing your savings. This re-optimisation, or change in your target asset allocation, of your portfolio is the result of bringing to you the best-in-class from technology and investment techniques. Any portfolio management activity is always free of charge, as we firmly believe that intelligent investing shouldn’t be expensive.

On behalf of the entire StashAway team, here’s to intelligent investing.

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