Quarterly PortfolioBarometer

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1 PORTFOLIO RESEARCH AND CONSULTING GROUP Quarterly PortfolioBarometer NOVEMBER 2015 Natixis Global Asset Management s quarterly Portfolio Barometer offers insights into UK financial advisers model portfolios and the allocation decisions they are making. Natixis s Portfolio Research & Consulting Group works with financial advisers and other intermediaries to analyse and enhance their model portfolios and help them develop investor portfolios suited to today s complex markets. The Portfolio Barometer highlights trends uncovered by the analysis of 177 model risk-rated portfolios managed by UK financial adviser and wealth management firms in the three months from July to September of The model portfolios under review were grouped into three risk-rated categories: Conservative, Moderate and Aggressive 1, based on the definitions given by the firms themselves. All statistics in this report are based on simulated returns of advisers current model portfolios over the three years ending September These statistics are therefore representative, rather than actual historical figures. Q Key findings Asset allocation trends Advisers cut fixed income allocations in Conservative and Moderate risk portfolios amid continuing uncertainty over the timing of rate rises Majority of reallocation from fixed income went to Cautious Allocation funds perhaps reflecting the recognition that such funds can respond more quickly to changing market conditions Remaining fixed income allocations see hints of increasing exposure to government bond funds Alternatives funds Alternatives funds are primarily held in Conservative and Moderate portfolios, with 25% and 16% of average allocations, but surprisingly little in Aggressive portfolios with just 6% Alternatives used are mainly Direct Property and Multi-alternative funds, yet the Multi-alternative funds offer the least diversification benefits Despite providing an excellent diversification opportunity advisers are reluctant to use alternatives perhaps a missed opportunity Fund managers need to do more to help advisers and their clients understand the benefits of allocating to alternatives in portfolios 1 Refer to the methodology section at the end of the document for more details on the industry benchmarks used for Conservative, Moderate and Aggressive risk-rated categories INVESTMENT PROFESSIONAL USE ONLY

2 Section 1 Quarterly Asset Allocation Trends The average asset allocations across Conservative, Moderate and Aggressive portfolios in the third quarter of 2015 are outlined in Chart 1 below: CHART 2: AVERAGE CHANGE IN ALLOCATION BETWEEN Q2 AND Q % 6% 4% 2% 0% Allocation Alternative Equity Fixed Income Money Market CHART 1: Q PORTFOLIO WEIGHTINGS BY RISK CATEGORY 2 CONSERVATIVE Allocation Alternative 27% Equity Fixed Income Money Market MODERATE Allocation Alternative Equity Fixed Income Money Market AGGRESSIVE Allocation Alternative Equity Fixed Income Money Market 14% 3% 56% 8% 23% 2% 1% 2% 6% 89% 17% 11% 25% 16% Source: Natixis Portfolio Research & Consulting Group -2% -4% -6% -8% CONSERVATIVE MODERATE The Portfolio Research & Consulting Group compared the average allocations between Conservative, Moderate and Aggressive peer groups to understand the changes between Q and Q This is shown in Chart 2. Fixed income falters Fixed income markets have painted a very unclear picture in recent months, with the US Fed refusing to rule out an interest rate rise before the end of the year. This uncertainty has contributed to the reluctance of investors to take duration risk. This trend was evident in the model portfolios reviewed by Natixis as well. The Conservative portfolios showed the biggest switch, cutting allocations to fixed income funds by 7% on average, while Moderate portfolios cut fixed income by 6%. In both groups, this was primarily reallocated to cautious multi-asset allocation funds. Commenting on the findings, James Beaumont, Head of the Portfolio Research and Consulting Group at Natixis Global Asset Management said: It is no surprise that investors are feeling unsure what to do with fixed income at the moment. The continuing uncertainty emanating from various central banks around rate AGGRESSIVE rises has led many advisers to move the money elsewhere. The majority of the money taken out of pure fixed income funds over the past quarter has now been invested in cautious allocation funds. Despite being unconstrained, these funds are still heavily weighted towards bonds, so the reallocation may simply be a case of advisers looking for help from a third party in managing duration risk ahead of any rate rises. Government bond resurgence? Within the broader shift away from fixed income, an analysis of the remaining bond fund holdings told an interesting story. While the third quarter saw advisers selling large chunks of their Conservative portfolios fixed income allocations, the data showed that average allocations to government bonds in fact increased to an average of 2% of portfolio holdings. It may be too early to tell, but there are signs advisers are making selected tactical allocations to government bonds in their defensive portfolios, said Beaumont. As well as appearing in the data, we have had a number of conversations with advisers who are mulling increasing their government bond allocations.

3 Government bonds have very low correlations with other types of fixed income funds, so from a diversification perspective it makes sense to retain a select allocation, especially in defensive portfolios. Section 2 Alternatives What alternatives do portfolios hold? For the third quarter of 2015, the Portfolio Research and Consulting Group reviewed the use of alternative investments 3 within adviser model portfolios. As shown in Chart 1 on the previous page, alternative investments are held predominantly in Conservative and Moderate portfolios, comprising 25% and 16% of these portfolios capital respectively, and only sparsely in Aggressive portfolios, with 6% of allocations. The analysis found that the primary alternatives used are Direct Property funds and Multi-alternatives, as shown in Chart 3 to the right. Excluding property, the average allocation to alternatives fell substantially, with just a 13% allocation to alternatives ex-property in Conservative portfolios, 8% in Moderate and 3% in Aggressive. CHART 3 ALLOCATION TO ALTERNATIVES AS A PERCENTAGE OF OVERALL PORTFOLIO ALLOCATION Conservative Moderate Aggressive Alternative TOTAL 25.2% 16.4% 6.4% Long/Short Equity 1.6% 1.7% 1.0% Market Neutral 1.3% 0.5% 0.0% Multi-alternative 8.8% 5.0% 1.5% Other Alternative 0.8% 0.3% 0.1% Property 12.2% 8.5% 3.7% Miscellaneous 0.3% 0.3% 0.1% Commodities 0.1% 0.0% 0.0% Alternative ex-property 13.0% 7.9% 2.7% CHART 4 PERCENTAGE OF PORTFOLIOS HOLDING EACH ALTERNATIVE CATEGORY Conservative Moderate Aggressive Alternative TOTAL 90% 84% 61% Long/Short Equity 27% 26% 17% Market Neutral 13% 10% 0% Multi-alternative 65% 60% 25% Other Alternative 13% 13% 2% Property 83% 76% 51% Miscellaneous 6% 6% 3% Commodities 4% 3% 2% It is clear that alternatives are a popular asset class to hold in more defensive portfolios; 90% of Conservative and 84% of Moderate portfolios held some allocations to alternatives. Yet they are less used in aggressive, growth seeking portfolios, with just two thirds (61%) holding some alternatives exposure. Moreover, the average number of alternative funds held in Conservative and Moderate portfolios was three; in Aggressive portfolios just one. 2 Data shows average allocations to asset classes (based on Morningstar categories) from 59 PRCG clients surveyed between July and September The sample group includes 48 Conservative portfolios, 70 Moderate portfolios and 59 Aggressive portfolios. 3 Alternative investments include the Morningstar categories: Long/Short equity funds, Market Neutral funds, Multi-alternative funds, Other alternative funds (includes global macro, trend following, event driven), Property funds, Commodity funds and Miscellaneous (mostly listed infrastructure and private equity).

4 CHART 5 ALLOCATIONS AS A PERCENTAGE OF TOTAL ALTERNATIVES ALLOCATION CONSERVATIVE Long/short equity 8% Market neutral 5% Multi-alternative Other Alternative Property Miscellaneous Commodities MODERATE Property Miscellaneous Commodities Property Miscellaneous Commodities 35% 4% 47% 1% 0% Long/short equity 9% Market neutral 3% Multi-alternative Other Alternative AGGRESSIVE 31% 2% 53% 2% 0% Long/short equity 13% Market neutral 0% Multi-alternative Other Alternative 23% 3% 58% 2% 1% As a proportion of the overall allocation to alternatives, property funds made up nearly 50% of the total allocation in Conservative portfolios and nearly 60% in Aggressive. Meanwhile, the second largest allocation was to multi-alternative funds, which comprised approximately a third of the alternatives allocations of Conservative and Moderate funds and a quarter of that of Aggressive funds. Beyond some allocations to long/ short equity funds, there were hardly any further allocations to alternative investments. How much diversification do alternatives offer? Chart 6 below shows the average three-year correlation of alternatives funds in each category to the average of other alternatives funds, funds from traditional asset classes and the average of the three portfolio peer groups. For example, Long/ Short Equity funds had an average correlation of 0.32 to other Long/Short Equity funds, and 0.18 to Market Neutral funds. Only funds found in client portfolios were analysed, in order to focus on what is actually held by clients. The analysis clearly shows that almost all alternative fund categories have low or very low correlations to one another, to traditional asset classes and to client portfolios. Yet the data also showed that when compared with the wider portfolios, the most popular ex-property alternatives funds (multi-alternatives and long/short equity) have the highest correlations, and thus offer the least diversification benefits. The multi-alternative funds selected were highly correlated with all three portfolio peer groups. Even property funds, which appear to have the lowest correlations and are the most popular category, are problematic. Their infrequent valuations mean the net asset value reflects stale pricing, artificially lowering the correlation figures of the fund. Matthew Riley, Head of Research, commented: From a diversification perspective, adding alternatives to a portfolio makes a huge amount of sense. However, advisers should CHART 6 CORRELATIONS OF ALTERNATIVES FUNDS 4 Long/Short Equity Market Neutral Multi-alternative Other Alternative Miscellaneous Property Commodities UK Equities Global Equities UK Gilts Global Bonds Conservative Moderate Aggressive Long/Short Equity Market Neutral Multi-alternative Other Alternative Miscellaneous Property Commodities UK Equities Global Equities UK Gilts Global Bonds Conservative Moderate Aggressive Source: Natixis Portfolio Research & Consulting Group

5 investigate alternatives funds carefully when making selections often those easiest to understand offer the least benefits. Most are choosing multi-alternative funds as their main non-property alternatives vehicles when in fact they are the most correlated of all alternative fund types to the wider portfolio. Some do offer excellent diversification, however, so careful research and selection is key. We think that advisers should consider all alternatives at their disposal, as there are some compelling arguments from a diversification perspective. Alternatives impact on portfolios As well as considering the diversification benefits of alternatives, the Portfolio Research and Consulting Group analysed the risk and returns offered by the different alternatives funds categories. Chart 7 below shows the marginal risk of various alternatives categories against the wider portfolios. Marginal risk shows the impact on overall risk levels of adding a small allocation to the portfolio a fund with positive marginal risk would therefore increase overall risk levels. On average, all alternatives strategies except commodities have a negative marginal risk to the average portfolio, meaning adding them to a portfolio would tend to reduce its overall risk. CHART 8 AVERAGE MARGINAL RETURN OF EACH ALTERNATIVES CATEGORY Conservative Moderate Aggressive Long/Short Equity Market Neutral Multi-alternative Other Alternative Miscellaneous Property Commodities Indeed, nearly all of the individual alternatives funds seen by the Group in advisers portfolios appear to have this risk reducing effect, due to the low correlation between the average alternative fund and the average portfolio (even in the case of funds with relatively high risk on a stand-alone basis). In order to consider return, Chart 8 above shows the marginal return (the impact adding an allocation would have on the overall portfolio return). Return generation is a potential sticking point for alternatives funds in most cases, apart from Conservative portfolios, adding alternatives funds to a portfolio can reduce the overall returns it can generate. However, the analysis found many examples of individual alternatives funds generating positive marginal return across all portfolio types, so manager selection is key. Riley commented: On average, alternatives funds are fantastic diversifiers. Yet at the same time many of the funds available to advisers offer steady if unspectacular returns. This, however, doesn t tell the whole story there are many examples of alternatives funds that can also add excellent returns to a portfolio. Why aren t advisers using alternatives more, particularly those that might offer real diversification benefits or returns? It may be because they are uncertain about how exactly these funds work, and feel unable to explain them to their clients certainly an issue which has been raised to us in the past. It is the job of the fund managers to make sure advisers are given everything they need to educate themselves, and just as importantly their clients, on the benefits these types of fund can bring to a properly diversified portfolio. 4 Correlation values are on a scale of -1 to 1, where 1 indicates a perfect linear relationship (i.e. the securities move in lock-step), and -1 indicates a perfect inverse relationship (i.e. when one security rises, the other falls by the same amount). A value of 0 indicates no correlation at all. 5 Marginal risk is correlation of the fund to the portfolio multiplied by its standard deviation. The figures in the table represent basis points of portfolio risk per 1% allocation change. CHART 7 AVERAGE MARGINAL RISK OF EACH ALTERNATIVES CATEGORY 5 Conservative Moderate Aggressive Long/Short Equity Market Neutral Multi-alternative Other Alternative Miscellaneous Property Commodities

6 Methodology All figures, unless otherwise stated, are derived from detailed analysis conducted by the Portfolio Research & Consulting Group of 177 model portfolios from 59 firms across the UK between 1 July and 30 September About the Portfolio Research & Consulting Group The Portfolio Research & Consulting Group provides a free and bespoke service to advisers to help build more durable portfolios for their clients. The group uses advanced analytical capabilities derived from sophisticated, institutional grade software to help improve the way advisers create and manage their portfolios. More information is available at About James Beaumont, International Head of Portfolio Research & Consulting Group for Natixis Global Asset Management In this UK based position, James Beaumont has responsibility for analytical services the portfolio research and consulting team offers to clients across Europe, MENA and Asia. He oversees a team of 6 Consultants and 6 Analysts, all experienced and highly qualified professionals that provide detailed portfolio analysis to help advisers improve the way they create and manage client portfolios. James Beaumont s team is independent and focuses its analysis on risk exposures to improve diversification with a goal of achieving better returns with lower overall volatility. James Beaumont was previously at Standard Life Investments, where he was a Senior Investment Analyst in SLI s Fund Solutions team. Prior to that, he held roles as a Fund of Hedge Funds Portfolio Manager at Thames River Capital LLP and as a Partner and Senior Analyst at Eden Rock Capital Management. About Matthew Riley, Head of Research, Portfolio Research & Consulting Group for Natixis Global Asset Management Matthew has over 17 years experience in the investment management industry, and previously specialised as a risk consultant at Falcon Money Management where he was responsible for risk management, investment process and analytic reporting. Matthew also worked as an Investment Director at Aida Capital, the Fund of Hedge Funds arm of Standard Life Investments where he created portfolio construction, statistical analysis and risk management tools. Prior to that he spent five years at Union Bancaire Privée where he managed fund of hedge funds portfolios for institutional and high net worth clients. He has a master s degree in Chemical Engineering from Pembroke College, Cambridge University. To learn more about how the Portfolio Research and Consulting Group can help you build more durable portfolios for your clients, please contact your Natixis Global Asset Management sales representative or uk-info@ngam.natixis.com

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8 For Press queries, please contact: Samia Hadj, Global Public Relations Tel: +44 (0) About Natixis Global Asset Management Natixis Global Asset Management ( billion AUM 1 ) is a multi-affiliate organisation that offers a single point of access to more than 20 specialised investment firms in the Americas, Europe and Asia. The firm ranks among the world s largest asset managers. 2 Through its Durable Portfolio Construction philosophy, the company is dedicated to providing innovative ideas on asset allocation and risk management that can help institutions, advisers and individuals address a range of modern market challenges. Services offered by the Portfolio Research & Consulting Group are provided exclusively by NGAM UK Ltd, authorised and regulated by the UK Financial Conduct Authority. The information contained herein is provided solely for information only and does not constitute a solicitation to buy or an offer to sell any financial products or services. Approved in the UK by NGAM UK Limited, authorised and regulated by the Financial Conduct Authority (register no ). Registered Office: NGAM UK Limited, One Carter Lane, London EC4V 5ER. 1 Assets under management (AUM) as of 30 September Cerulli Quantitative Update: Global Markets 2015 ranked Natixis Global Asset Management, S.A. as the 17th largest asset manager in the world based on assets under management ( billion) as of 31 December PRCG11UK-1115 INVESTMENT PROFESSIONAL USE ONLY PortfolioBarometer