As might have been expected, the extreme nature of the economic downturn continues to spawn ways for investors to navigate the financial markets.
The latest iteration, which should draw considerable attention when it officially hits the street this week, is the Aim Balanced-Risk Allocation Fund (ABRZX).
The fund, which cleared Securities and Exchange Commission registration Friday and has been kept under tight wraps by Atlanta-based
Invesco Ltd., throws a monkey wrench into traditional thinking related to balanced portfolios and investment risk.
According to the research conducted by
Invesco's global asset allocation group, a standard portfolio of 60% stocks and 40% bonds derives 90% of its risk from the stocks.
Now, that isn't a problem during non-inflationary growth market cycles such as the mid-1980s and the late 1990s. But as a lot of investors have come to realize over the past 18 months, a 60% allocation to stocks can crush a portfolio in a recessionary market cycle.
The downfall of most balanced strategies, according to
Invesco's research, is that they rely on asset allocation to drive risk.
By contrast, the new Aim fund's strategy sets a target risk contribution equal to one-third each of stocks, bonds and commodities, and then builds an allocation designed to achieve that risk.
The case for the balanced risk allocation boils down to the idea that one or more of the three main categories will do well in each of the three main market cycles: Inflationary growth favors commodities, non-inflationary growth favors equities, and recessionary-deflationary favors bonds.
“Our expectation is that over time, the portfolio will do better than traditional balanced portfolios in every market, including periods of positive stock market growth,” said Scott Wolle, lead manager on the fund and chief investment officer of
Invesco's global asset allocation group.
In order to achieve this risk exposure, the team of five portfolio managers and an analyst construct a strategic asset allocation portfolio that includes a 60% fixed-income weighting, 20% stocks and 20% commodities.
The strategic allocation is evaluated annually, but the underlying exposure of each of the broad market categories is evaluated and re-balanced monthly if necessary to adjust the risk allocation based on the team's market analysis.
For example, the risk allocation is set up to be slightly underweight fixed income, which includes U.S. Treasuries, German Bunds, Japanese government bonds and United Kingdom Gilts.
The risk exposure to commodities is slightly overweight. This category is made up of crude oil, copper, gold and soy meal, providing exposure to the following broad commodity groups: energy, industrial metals, precious metals and agriculture.
The equity risk allocation, which is also slightly overweight right now, uses index-based derivatives to provide exposure to the Standard & Poor's 500 stock index, the Russell 2000 Index, the FTSE 100 Index, the Dow Jones EuroStoxx 50 Index, the Tokyo Stock Price Index and the Hang Sang Index.
The derivatives, in the form of exchange-traded futures, don't expose the portfolio to currency risk which would otherwise reduce the benefits of a globally diversified portfolio.
Invesco started developing the strategy in early 2007 for an institutional client, and that version has been up and running since the third quarter of last year.
The retail version, in the form of a registered mutual fund, will officially launch Tuesday.
A key element of the strategy — and something that financial advisers and their clients will need to get their heads around — is the emphasis on risk allocation as opposed to investment allocation.
The 60% fixed-income weighting that could set off some alarms by investors seeking growth is not the point to focus on, according to Mr. Wolle.
“Two-thirds of the risk is coming from [stocks and commodities] that do well in periods of economic recovery,” he said. “And because of our diversification, we're getting more return per unit of risk than your average balanced fund.”
And that diversification, Mr. Wolfe added, isn't wasted on quantity for the sake of diversification.
“People usually think of diversification as meaning more investments, but what they need is low correlation,” he said. “It's the nature of the assets, not the quantity of the assets, that reduces risk.”
The fund is benchmarked to a blend of 60% of the S&P 500 and 40% of the Lehman Aggregate Bond Index.
It is also expected to fit in the world allocation mutual fund category as determined by Morningstar Inc. of Chicago.
On paper, at least, the strategy looks like a no-brainer, particularly in the wake of recent market turmoil.
Mr. Wolle, clearly and perhaps rightfully biased, said that he plans to move his entire retirement portfolio into the fund.
Time will tell if the strategy can live up to expectations. But before that, the real test will be getting advisers and their clients to look beyond asset allocation to focus on risk allocation.
“It uses a more realistic approach,” Mr. Wolle said. “And it's different, but different makes a lot of sense right now.”
A new Investment Insights column appears every Monday on InvestmentNews.com. E-mail Jeff Benjamin at [email protected].
