The Systematic Asset Allocation Lego blocks

We’ve all heard them before – ‘Smart Beta,’ ‘Risk Premia,’ ‘Strategic Beta,’ ‘Factor Investing,’ ‘Thematic Strategies’ – commonly used (and oft-abused) buzz words that now seem to headline many investment discussions, industry commentary and panel presentations. Are these ideas a novel stroke of genius, or a revamp or rebrand of decades-old concepts? Quants, understandably, lean unwaveringly toward the latter. Either way, what is for certain is that the recent polarization of views surrounding such investment strategies has influenced how investors are thinking and operating. A key element of this approach lies in its explicit modularization. An increasing number of products are being designed to serve as cheap yet efficient building blocks that provide transparent and as clean as possible exposures to underlying factor(s). But, as we all know, prying open a box of Lego blocks and scattering them on the floor is merely step one.

The impact of this trend – particularly on active asset managers – has been substantial. Scrutiny has intensified while justifying fees of the past has become measurably more difficult. Importantly, the availability of such products has altered the perspective of both asset owners as well as the Investment Solutions divisions that are structuring and implementing these solutions. The next step is to find the appropriate pieces and put them in the correct place. There is no single way to allocate assets and, thus, there are no instructions on the box. But there is no need to dive in blind; knowing what one is ultimately trying to build will guide and frame the assembly strategy. Every investor solution is unique, driven by risk appetite, return expectations, investment horizons and beliefs.

Asset allocation – both tactical and strategic – is rapidly evolving into a more sophisticated, integrated and systematic process. The traditional discretionary, top-down approach is being enhanced with techniques and workflows borrowed from quantitative asset management:

  • Optimization is more wide-spread. As a result, companies that are managing the process through factor allocation are expanding their organizations and funneling greater resources to researching and implementing systematic approaches. For example, organizations started running more sophisticated scenario analysis to research and identify return expectations. Those expectations are then used within multi-period optimization processes in order to truly account for nature and scope of allocation requirements and systematically target risk/return profiles per period.
  • At the same time, risk models are evolving away from static asset class time series. Interest is growing for cross-asset custom asset allocation factor models where allocators can select factor definitions and model structure based on their processes as well as consistently combine a traditional asset-based approach with a factor-based approach. This allows for the capture of correlations at multiple levels and, ultimately, the improvement of exposure management and risk budgeting. In addition, more sophisticated scenario and stress-testing solutions are becoming standard practice.

Beyond just assembling the bricks, an important part of step two involves selecting and employing better and different pieces for an ideal outcome – and do so at scale.

Logically, an evolution in the way asset allocators choose to operate has a profound impact on the extent to which asset managers must rethink their products and value propositions. Winning mandates will depend increasingly on the quality and transparency of building blocks as well as an ability to design and implement an appropriately-tailored investment solution for each client.

Axioma’s extensive experience in this space includes partnering with a range of top-tier institutions to build factor baskets, implement asset allocation strategies and provide custom asset allocation models and stress-testing tools. To continue the conversation or to learn more, contact us.

Alessandro Michelini

Alessandro Michelini is responsible for Axioma’s Portfolio Solutions business in EMEA where he oversees the efforts of the client facing organization in the portfolio construction and analytics space. Alessandro joined Axioma in 2008 and successfully established the firm’s presence in EMEA acting as Head of Sales for the region. Prior to Axioma, Alessandro held a number of positions ...

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