More tools in the asset allocation toolkit on ASX
Simplest way to add value is being in the right asset at the right time.
When most investors think of active portfolio management, they think of the concept of picking Australian shares they believe will outperform the return of the broad Australian sharemarket (the S&P/ASX 200 index).
By picking the correct shares, such an investor is aiming to generate excess returns, known as “alpha”, above the market return, for a better investment outcome.
Stock-picking aims to take advantage of inefficiencies in Australian shares by focusing on increasing exposure to companies that may be undervalued and decreasing exposure to companies that may be overvalued.
Australian shares are but one asset class and investors who focus on it alone may be missing out on opportunities to generate additional alpha, especially if Australian shares look overvalued relative to other asset classes.
Asset allocation is the practice of investing in not just one asset class but in several, such as cash, bonds and fixed interest, international equities, property, and alternative assets such as commodities and infrastructure.
Asset allocation can provide several benefits to portfolios, including:
- Improved absolute returns. Because different asset classes perform differently in various types of market conditions, asset allocators potentially can outperform in both rising and falling markets, by increasing exposure to undervalued asset classes and decreasing exposure to overvalued ones.
- Diversification and risk reduction. Adding uncorrelated or low-correlated assets (those that do not have a strong connection) provides added diversification, which can potentially reduce risk and volatility.
The importance of asset allocation can be seen by looking at AMP Capital research on asset class returns over 20 years.
Knowing when to move between asset classes
The simplest way to add value through asset allocation is to be in the right asset class at the right point in the business cycle. Many asset classes move inversely or in a non-correlated manner to each other. The key is picking the right asset class for the economic environment.
Here is an illustration of the typical behaviour of different assets classes throughout the business cycle, although it is important to note that the behaviour of asset classes in the past is not an indication of future behaviour.
Chart 1: Illustrative asset class exposure over the economic cycle
Knowing how to implement asset class decisions
Once you have decided to broaden your asset class exposure, the next question is how an individual investor can simply and efficiently gain access to other asset classes.
The growth in exchange-traded products (ETPs) in Australia has led to the democratisation of investment in a variety of asset classes. Asset classes, exposures and strategies that previously were only available through unlisted managed funds are now available in the same way as you access Australian shares, on ASX.
I am not suggesting this is the only way to access a variety of asset classes, but it is worth knowing some of the benefits of having ETPs available in your asset allocation toolkit:
- They are quoted on ASX, just like Australian shares, meaning that irrespective of the asset class exposure they provide, they can be purchased, settled and held on your CHESS account or nominated shares platform.
- They can be bought or sold during the trading day.
- They are among the lowest-cost investment tools available.
- They provide instant diversification to an asset class or to a sector or geographic region within an asset class.
- They are transparent – holdings within a specific ETP are typically disclosed daily, meaning you know exactly what the constituents or underlying assets within the fund are.
As with any type of investment, there are things you should consider before investing, including, but not limited to:
- Evaluating your investment goals and ensuring the selected fund meets your requirements. The best way to do this is to read the relevant product disclosure statement (PDS) before making an investment.
- Learning how ETPs work more generally. The ASX has an Exchange-Traded Products online course available to assist in education. In addition, ETP issuers have a wide variety of resources available.
Intra-asset class exposures
As an asset allocator, you also have the ability to make intra-asset class decisions with the increased variety of ETPs available on ASX. For example, your international equities exposure can be achieved by selecting:
- A simple broad global equities exposure.
- Individual country exposures, such as the United States, Europe or Japan.
- Specific global sector exposures, such as healthcare, technology, banks or cybersecurity.
Investors also can take leveraged tilts (increasing portfolio exposure) towards certain markets. There are several internally geared exposures available through ETPs across broad equity market exposures and currencies.
There are also ETPs that allow you to hedge portfolios in falling markets. These funds allow you to profit from, and defend against, falling sharemarkets. Be aware that funds that provide geared exposure accelerate your potential for both gains and losses.
How to find out what ETPs are available on ASX
A full list of ETPs available on ASX can be found here.
In addition, ASX publishes a monthly funds update that provides a snapshot of the asset class categories, including inflows and outflows.
As the ETP market continues to grow and the asset classes and exposures continue to expand, investors now have access to an array of asset allocation tools to consider beyond Australian shares, and all available in the one marketplace, on ASX.
ETFs and other ETPs has information on the features, benefits and risks of these products.