An interesting article on multi asset allocation from Willis Towers Watson, prompted us to explain more in detail, why it is we believe in global equity portfolios, and why they should be balanced on a risk parity principle. The defining principle for ANNOX in a diversified equity portfolio is essentially the same principle as a diverse multi asset principle: One needs to balance out the risk based on groupings of instruments, expected returns, correlation and volatility to get the highest possible return relative to a set risk tolerance for a portfolio. The opposing principle to that, is the passive portfolio, that is scaled simply by market weight.
Our Investment strategy is to diversify as much as possible using a hierarchical risk parity (HRP) approach, emphasizing the risk contribution within each model strategy, market and stock – rather than the simple naive cash exposure.
In comparison below the MSCI World index (Includes all developed markets globally)
The MSCI World index is basically the reference index, that most global equity portfolios are measured up against. That is because it represent the closest and most accurate approximation of the market portfolio. It´s constituents (mid – large cap equities) is weighted in the portfolio according to market weight, which is also why the majority of its constituents are located in USA. It also represent the single true passive solution to equity investing, since this is the only real solution where practically no re-balancing is needed, and no stock picking has been done, not even on a sector or country level. In essence, all other equity portfolios, can have either higher or lower performances compared to the reference portfolio ex trading, and are effectively active portfolios. Combining all other active portfolios based on market weight, will theoretically then yield same performance as the reference portfolio ex trading cost.
The best thing about the market portfolio, is it has a very small single stock exposure, but on the other hand it still has an exceptionally high country exposure to the US. In ANNOX view a concentrated exposure of 55% to the US market (and sometimes even up 65%), is an unnecessary and excessive concentrated risk – especially to the non-US investor. Some funds never the less create equity portfolios that has the same country exposure as the market portfolio. This is very effective for an portfolio manager as a way, to have performance numbers that do not stray to far away from the marketportfolio or benchmark – never the less it is not an ideal portfolio from a risk and return based quantitative view.
From a quantitative “Markowitz” porfolio optimizing point of view, the conclusion is, that it is far superior to create a portfolio with a more equal risk based view. Hence we take the consequence of that and instead adopt a portfolio optimizing approach, where we seek to limit the risk as much as possible, thus achieving the best diversification that can be done, with high return expectations.