As diversifying a portfolio is one of the key drivers behind generating performance, proper asset allocation is of the essence. Spreading the holdings across different jurisdictions, industries, companies or sectors (sometimes even different asset classes), reduces the risk and ensures that “not all is lost” when for instance a specific sector may plummet. True diversification is however not about spreading the portfolio as thinly as possible, but ensuring that the underlying assets behave differently to one another in response to market events or news. This is measured by correlation.

Watch our video on Asset Classes here.

Correlation

Correlation examines underlying portfolio holding relationships and helps portfolio managers to predict how one asset will behave, based on the movement of another asset. If two securities move in the same direction, they have a positive correlation. When they move in opposite directions, they display negative correlation. Ideally, a portfolio should hold some securities that behave differently to one another as it manages the risk within a portfolio. A well correlated portfolio is key to successful investing and generating a good return, without taking any unnecessary risk. Watch our video on Correlation here.

Top-down, Bottom-up

Portfolio managers have different approaches to ensure a diversified selection of investments in the portfolio.

The top-down method studies the wider economic and macroeconomic factors first, such as the total production, income and expenditure in the economy, level of employment, interest rates, taxation and so forth. If a country’s economic outlook is positive, investors would be more enthusiastic to invest in that country and does not pay too much attention to the underlying companies that they are investing in.

The bottom-up method works the other way around and starts by evaluating the potential of a specific company and not the wider economic factors. The company’s products and services, management team and financial structures play fundamental roles in determining if the company would generate the expected returns.

Strategic and tactical tilting

One of the strategies that portfolio managers use is a dynamic approach to asset allocation, using both strategic and tactical methods.

Strategic asset allocation is a portfolio manager’s fixed, long-term view on the mix of assets to achieve the objective of generating the highest possible return for the level of risk taken.

Tactical asset allocation allows for adjustments to the asset mix to capitalize on opportunities that present themselves in the market and subsequently enhance returns.

Blending these two methods means that the portfolio manager will have a set, strategic view for the long run, but may deviate from the fixed asset allocation for a short period, taking advantage of certain market movements. This dynamic approach integrates the best of both worlds: enhancing returns, whilst simultaneously mitigating risk over time.

Volatility

Volatility measures how much an asset’s return will deviate from its average performance or benchmark. In essence, it examines the frequency and extent at which an asset’s price will rise or fall. Volatile assets, like equities, are considered to be riskier, because their performance tends to be unpredictable as there can be sudden or large changes in their prices. When the price of an asset changes at a slower rate over a longer period, it is considered to be less volatile. Volatility creates opportunities for portfolio managers to take advantage of the markets and to generate a profit.

At Fairtree, our approach to investment management is unique, as we manage a diversity of long-only and alternative investment portfolios across all global asset classes. Adhering to Fairtree’s sound investment philosophy, our acclaimed specialist teams blend different investment philosophies, strategies, processes and analytics to create elite solutions.

A Top-down and Bottom-up view

We follow a meticulous top-down and bottom-up analysis to ensure a diversified selection of investments in each fund.

The top-down method studies the wider economic and macroeconomic factors first, such as the total production, income and expenditure in the economy, level of employment, interest rates, taxation and so forth. If a country’s economic outlook is positive, investors would be more enthusiastic to invest in that country and does not pay too much attention to the underlying companies that they are investing in.

The bottom-up method works the other way around and starts by evaluating the potential of a specific company and not the wider economic factors. The company’s products and services, management team and financial structures play fundamental roles in determining if the company would generate the expected returns.

Quant driven funds

A number of funds include complex quantitative algorithms, time-tested to derive market value through unique strategies to generate wealth for our clients. This is combined with a hybrid model of human expertise and experience in decoding the quantitative models, adds another layer in deciding final portfolio inclusions.

First in South Africa to include alternative assets in blended portfolios

Standard portfolios in the financial industry largely consist of a blend of conventional assets, such as equities, property, fixed income, as well as cash and cash equivalents. Alternative assets are however a range of unconventional / “non-traditional” financial securities to invest in, which include Hedge Funds, Private Equity and Commodities.

Fairtree is the first in South Africa to follow an exceptional and influential approach to portfolio construction: blending traditional asset classes with alternative strategies and assets. Our portfolios include directional equity, quantitative and directional equity, directional fixed income and credit, equity diversifiers and soft commodity diversifiers.

As asset allocation primarily drives performance, these combinations in portfolios provide outstanding diversification opportunities and has proven to generate superior excess return for investors.

Strategic and tactical tilting

By blending strategic and tactical tilting, our portfolio managers remain true to their strategic view for the long-term, whilst taking advantage of certain market movements in the short-term.

Our tailored investment portfolios have a “core”, which is invested in a diverse range of multiple asset classes, including local and offshore investments in equity, property and fixed income. Around the “core” we invest in “satellite” funds, which usually specialise in specific asset classes, enabling us to up-weigh or down-weigh across asset classes. This provides us with the opportunity to tilt the portfolio in accordance with different economic conditions, whilst staying true to our strategic view inside the core.

*The core itself does also contain a degree of tactical tilting.

This approach integrates the best of both worlds: enhancing returns and creating long-term wealth, whilst simultaneously mitigating risk.