When it comes to portfolio management, the ‘man versus machine’ debate has been one of the most discussed in recent times. The question is to what extent the advancements in quantitative research and the sophistication of software can replace intuition or common sense?
“Asset allocation tools are useful but, they are exactly that, a tool, and should never be used in isolation,” states Simon Miles, head of discretionary at Merrill Lynch Wealth Management Emea. The US-based group runs $1,500bn (€1,040bn), but refuses to give regional breakdowns.
“The human element, the human experience is very important in the asset allocation and risk monitoring process,” says Mr Miles.
This mantra is especially true in today’s uncertain times. Tools do rely on the quality of input they take and the human element comes from people’s experience. “No two situations are exactly the same but history teaches you a lot in terms of how markets will react. Any investment process is always in evolution; nothing is set in stone,” he says.
The financial crisis was a particular “watershed”, for global markets and in terms of the way people reacted to them, he says, but today’s extremely volatile markets prove to be as difficult. “What we are living at the moment is one of the most challenging market environments I have even seen in my 25-year career.”
Current markets are significantly driven by macro-economy factors – investor sentiment is very extreme and changes very quickly, sending shockwaves though global financial markets. “Investors are very much polarised in terms of risk on, risk off attitude. They either want to add risk or they desperately trying to take risk off the table and those cycles are very quick. That’s why we are seeing such volatile markets,” he explains, adding that this is also one of the reasons why it is very difficult to make money at the moment.
Concerns about the US debt and the eurozone crisis have put investors into a “risk off” mode for most of the summer, during July and August. Before, people were feeling much more comfortable with having risk positions, which reflected in markets performance.
While strategic asset allocation sets the long-term goals and should not change over time, it is the tactical moves that respond to evolving views on markets and economies.
“Sometimes it is difficult to see what the actual catalyst and turning point is. What might be the catalyst for risk on is if the US decide to go ahead with its third round of quantitative easing. If that happens, people will want risk and will want to get into cyclical stocks and particularly resources,” predicts Mr Miles.
How they compare
• At Merrill Lynch Global Wealth Management, the advisory business, legacy of its past as a brokerage firm, born in the US and expanded internationally, makes up by far the largest part of ML’s assets under management.
• The discretionary side is much smaller. The bulk of discretionary portfolios start at $3m for a segregated, bespoke offering. However the minimum account size is $1m. In this case the portfolio would usually be a funded solution.
“Equities are looking reasonably good value at this level and over the next six to 12 months we believe they will produce better returns than cash or bond markets. I believe at some stage we will increase our tactical allocation to equities from a neutral position to overweight in the next few weeks.”
Investors looking on a medium-term basis should make sure they are close to their long-term strategic benchmark in equities, as this is the way they are going to combat some of the inflationary pressures that are eroding their spending power.
Large cap growth companies are paying good dividends, and the income component of an investment is very important to long-term returns. For example, considering the total and not just the capital returns, many shares on the FTSE 100 at the moment are yielding more than government bonds.
Industry wise, the healthcare sector looks attractive. And the expected improvement on the returns of the Chinese stock market will drive up the prices of resource stocks. “In terms of region, on a medium-term basis we would still emphasise the growth economies of the world, such as Asia and to some degree Latin America,” he says.
In this fast-changing financial and economic environment, information is absolutely key. “You do have to be more proactive. But we are in the long-term management game – we are not the hedge fund that is trying to trade on a daily or hourly basis,” explains Mr Miles.
“We may decide not to do very much, but does not mean we haven’t been considering where we should make those changes or not. Often it is a very clear decision to not sell something.”
The allocation calls today are a lot bigger than they used to be historically. That is a function of the fact that markets react so much quicker now. Data is that much more freely available and the reaction time is smaller. “You have to be more nimble than you used to be,” says Mr Miles. “Also, clients ask us to take conviction-type bets.”
