GMI's Asset Allocation / The History

All of the portfolios we manage recognise 5 asset classes - cash, fixed interest, income stocks, core growth stocks, satellite growth stocks. For each portfolio an investment mandate is set in consultation with the client that reflects the objectives and tolerances of the investor. This we refer to as the ultimate asset allocation.

As part of our management we tactically alter the asset allocation, depending on where we assess we are in the investment cycle. This dynamic management though is constrained by the taxation status of the investor. We can't for instance just sell a NZ or Australian listed stock because we feel it's done its dash for the moment. Most of our clients are investors for long term and therefore only an unanticipated material change in circumstances is a legitimate reason to sell that type of stock. For non-Australasian stocks however it is more straightforward thanks to the FDR (Fair Dividend Regime) taxation scheme introduced in April 2007. It follows then that despite what our view on the optimal tactical or working allocation may be, most portfolios will not be able to adjust to it instantly.

The dynamic management of a portfolio then is tempered by two major lags

(a) recognition lag - the delay in us recognising that the investment cycle has altered direction

(b) implementation lag - the time between us knowing what we'd like to do and what we can do that's consistent with the client's investment purpose. While we can quickly make changes to portfolio positions for shares outside of NZ and Australia we are constrained in our ability to move client positions for NZ and Australian shares. Unless material changes arise for these shares, there is little we can do to change the position of the portfolio without infringing the client's taxation status. We must wait for these changes.

Having made these qualifications though it is interesting to see how our tactical strategy for asset allocation evolves over time. The following graph updates our history.

On the left hand axis is the proportion of a mandated growth portfolio we actually invested in growth stocks at various times over the last 16 years. The plain line illustrates that back in the late 1980's we were very lightly invested - the driver of this was that we'd just come off the 1987 crash and interest rates in New Zealand were very high indeed. We found it difficult to resist what those low risk alternatives had to offer so we maintained an overweight fixed interest position. As the dotted line shows the world stockmarket was moving pretty slowly still in the early 1990's.

From around 1991 we started lifting exposure to stocks from these very low levels, our preference was for emerging market stocks (eg:Templeton Emerging Markets) and also US large caps as a US recovery began to emerge. By 1993-94 the emerging market phenomenon had overshot and our portfolios felt an impact from that correction. We kept raising the weightings of growth stocks but moved more to US large caps (Coca Cola, Gillette) and tech (Microsoft, Intel).

By the end of 1996 when Alan Greenspan issued his famous "irrational exuberance" speech, we were 80% invested in growth stocks, over double the proportion we'd had in the post-1987 NZ recession days. Our stock holdings were almost exclusively non-New Zealand, even though the NZD was almost at 70 cents US at that time.

Our weighting to growth stocks kept lifting over the next 18 months although the emphasis was now heavily tech and the large US caps weren't so favoured. This is where things in the market started to get silly and PE levels over 100 were not uncommon. At this time we began the down-weighting of growth stocks in the portfolio although we were timid. Market appreciation was still rapid and it is very difficult to walk away from something that is making money. Nevertheless the NZ dollar by then was falling significantly, and we found it an attractive alternative. NZ fixed interest was the local asset preferred.

Then in March 2000 the US market peaked, although measured in plunging NZD terms that wasn't to come until October. So we took some more of the funds out of the US market and put it first in offshore cash and then by early 2001 we were buying NZ cash (the exchange rate was down to 40 cents and below).

The global stockmarket slump kept intensifying (it was to keep falling for 30 months until 2003!) and by now it was a matter of minimising the damage through continuing to reduce exposures, always mindful of the embarrassment a major market turnaround would cause. But we were pretty much convinced by then that investor nerves were strung out and that any recovery would be long and hard coming. We had a strong preference for cash returns - either through interest rates or, and this was a new theme, through high-dividend, very cheap New Zealand income stocks. The local economy was booming on the back of its very cheap currency so it grabbed our attention.

By mid-2002 we had started the investment programme into NZ income stocks and that remained until that winning strategy reached the end of its cycle by 2006 with the PE's of NZ stocks beginning to approach historically high levels and the NZD getting to new highs. The reduction in exposure to income stocks is necessarily slow because of the capital account status that constrains the speed at which investors can reduce NZ stocks. Indeed it wasn't until mid-2007 that these exposures got down to where we were comfortable with them.

Where have those funds been going? Initially we put them in cash - NZD, AUD, GBP and EUD - but then we started redeploying the funds into growth stocks with the target area being Asia and commodity producers and then multinationals with large international income.

As 2007 progressed we became more and more concerned about the ability of the US to keep powering along using other people's money to fund it's large deficit which is commonly called a "global" imbalance. So we have aggressively lifted the cash holdings in portfolios to buttress ourselves against the risk of stockmarket fallout coming from large imbalances and the concomitant borrowing that accompanies these. Our cash and bond holdings are now up to 40% plus of portfolios, a level in portfolios we haven't held since the early 1990's.

We'd expect our next move will be to run down cash and re-enter markets.

This pocket history we hope illustrates the dynamic nature of asset allocation as we manage these portfolios to firstly preserve capital value and secondly, enhance it. But despite the best laid plans there are those two lags that choke our ability to steer the perfect course. The recognition lag is something we can work on and continually improve, the implementation lag is something we have limited influence over.