It’s time to revisit your global equity exposure. With global equities having topped the asset allocation performance tables for the second financial year in a row, investors may find their portfolio has been distorted by the magnitude of the gains. The results may include inferior diversification and/or an asset allocation at odds with their current risk profile.

The gap between the performance of developed markets (+45%) and emerging markets (+21%) has been stark over the past two years, with investors far more cautious (to varying degrees over the 2014 financial year) about the credit issues within China and select macro headwinds facing a number of emerging market nations.

Risks of asset allocation “drift”  

Over the past two years, for a moderate asset allocation, global equities exposure in an investor’s portfolio may have drifted from a target 30% to 35.5% – a 5.5% increase in exposure. If left unchecked, an investor may end up with a portfolio that does match their long term investment objectives!

Managed funds with strong style biases do not sit at the top of the performance tables on a consistent year-on-year basis. If the portfolio or investments are not rebalanced back to the originally designed position sizes, the performance of a portfolio will become increasingly sensitive to that one investment due its larger size – thereby reducing the diversification properties of the portfolio and increasing overall volatility.

After such a large rally, and with global managed funds typically paying their largest (or only) distribution at June 30, investors should consider rebalancing their portfolio to ensure that the size of each global investment is not too large. If distributions are relatively low, consideration should be made to harvesting profits as a way of rebalancing the portfolio.

What to consider in a rebalancing exercise

At the investment level, consideration will need to be given to which managed funds or direct holdings have performed the strongest and which of those have been the weakest. What have been the underlying drivers of the performance? Is the performance sustainable? Clear consideration should be given to factors such as the level of exposure to ‘developed’ versus ‘emerging’ markets? Is healthcare going to continue to deliver 20% annualised returns for the next couple of years? What exposure is there to hedged or unhedged investments? What will happen to my equity investments should interest rates rise from here? What will happen if the US economic recovery stalls?  

Value managers, after an almost 8-10 year hiatus, have led the performance tables, alongside those with a clear aggressive growth/cyclical bias. Those managers with more conservative, quality-laden investment approaches (such as sustainable and long term track record of profitability, sound balance sheets and low cyclicality) have lagged quite markedly in the face of this market rally. In addition, any fund managers with any direct exposure to emerging markets is likely to have underperformed, purely as a consequence of the differential in performance between developed and emerging markets.

These trends are unlikely to continue indefinitely. Ensuring the appropriate mix of investments is maintained to avoid an over-reliance on ‘yesterday’s winners’ is key. Markets have an all too familiar habit of punishing those investors who place too great a reliance on recent performance.

For further analysis, download the full report:

•  Investment Strategy July 2014 (PDF, 1.1 MBA)