Q: What is the history of the fund?
At T. Rowe Price, there has been a steady evolution in the design and development of asset allocation portfolios, which our team has managed since 1990. We introduced the Global Allocation Fund in 2013. It’s broadly diversified across asset classes and geographies around the world.
This fund is the most broadly diversified of all our asset-allocation offerings, and was designed to provide long-term capital growth with a balanced approach and an attractive risk-adjusted return profile. Its base construction involves 60% equities, 30% debt instruments including bonds and money market securities, and up to 10% alternative investments through hedge funds. The portfolio has a truly global footprint and offers diversification across asset classes and sub-asset classes, with over 20 underlying strategies investing in securities representing 45 countries.
It can act effectively as a stand-alone offering for investors wanting broad and instant diversification across geographies and asset classes, and can also serve as a core component in tailoring a custom portfolio to meet more specific client objectives.
Q: How would you describe your investment philosophy?
Global diversification, both across asset classes and around the world, is a key principle of the portfolio’s design. We sought to build a robust portfolio that would do well across a broad range of market environments rather than optimizing it for a specific type of environment or set of assumptions.
Active management and fundamental research have long been cornerstones of our investment approach at T. Rowe Price. Over the last decade we have focused heavily on building out our global research resources, and the Global Allocation Fund draws on the full depth and breadth of these global fundamental research capabilities.
We worked closely with our Asset Allocation research team in the strategic design of the portfolio, in evaluating the underlying strategies and allocations. We carefully analyzed the sectors to determine their potential to either moderate the fund’s volatility or enhance its long-term risk return, as well as looking at how they might perform in certain market environments.
We sought to incorporate sectors with low correlations to take advantage of the ability of diversifying elements to reduce volatility. As an illustration, our investment grade fixed-income allocation has a longer duration profile, which is an efficient way to lower volatility as it benefits from the low to negative correlation between stocks and bonds.
Additionally, the fund has investments in alternatives strategies, such as a hedge-fund-of-funds and an equity index call-writing strategy, that can offer a return pattern that is uncorrelated to traditional asset classes. Our equity index call-writing strategy seeks to harvest the variance risk premium and as an uncorrelated source of return can offer a potential advantage relative to equities in a sideways market.
To help meet its objective of long-term growth of capital, the portfolio incorporates higher-growth elements like emerging markets and small-cap stocks. Also, within fixed income, the portfolio includes several higher income components such as high yield and floating-rate loans, as well as emerging market bonds.
Within emerging market bonds our approach seeks to benefit from the ability to allocate between emerging market local currency bonds and hard currency bonds. For example, hard currency bonds, which are principally dollar-denominated, generally offer slightly lower yields than emerging market local currency debt but without currency related volatility. Local currency bonds can offer an attractive yield advantage as well as the ability to express a view on the currency.
To enhance the potential for sustaining real long-term growth in the portfolio we incorporate several elements such as REITs and natural resources that tend to outperform broad equity markets in inflationary environments. Within fixed income we have both Treasury Inflation-Protected Securities (TIPS) and short-term TIPS, which similarly offer inflation protection but with less interest rate sensitivity.
Building upon our principles of diversification, no one source of value will dominate the portfolio.
Q: What is your investment strategy and process?
We have designed the portfolio to provide exposure to the broad global investment opportunity set, and our investment process seeks to add value through strategic portfolio design, tactical positioning among asset classes and sectors within the fund, as well as active management within the underlying strategies.
Over a full market cycle, generally about two-thirds of the value-add comes from security selection by the sector specialists who manage the underlying strategies drawing on the fundamental insights from our team of over 225 global research analysts. Other sources of value added come from asset allocation related elements including the diversified strategic portfolio and from the tactical overweighting or underweighting sectors in the portfolio.
Our active management is built on strong fundamental research capabilities across a broad suite of underlying strategies including growth and value style portfolios in U.S. and international equities, as well as emerging market equities and fixed income. We cover companies in the full range of market capitalizations both here and abroad. Fundamental research is also an important part of our fixed income investment process and is critical in areas such as high yield bonds where there can be more meaningful credit risk.
Our investment strategy also draws on the insights of our Asset Allocation Committee to determine whether to overweight or underweight an asset class or sub-asset class based on our outlook for the economic and earnings environment and where we see the most attractive risk-adjusted opportunities. These senior investment professionals have formed the positioning of the firm’s asset allocation portfolios since 1990.
Relative valuation is an important consideration in our approach to tactical positioning among sectors within the portfolio. We characteristically look to overweight segments of the market which we believe are undervalued. When tilts are made in the portfolio, they are done with a six- to 18-month investment horizon. Where attractive valuations are seen, we add to segments through measured moves that typically build into more meaningful positions.
We are patient investors who express our tactical views – but with guardrails. For example, we have a neutral allocation of 60% to equities and an allocation range of +/-10% to overweight or underweight based on valuations as well as our outlook for the economy and other factors likely to drive corporate profitability and interest rates.
We also seek to moderate risk through broad global diversification and inclusion of sectors and strategies that target specific factor exposures and perform well in a range of market environments, whether inflation, declining dollar, or periods of low growth.
The most recent market environment highlights the importance of diversification and having balancing elements in a portfolio when a sudden risk event occurs. In the aftermath of Brexit, our longer duration fixed-income components offered this balance. Emerging market equities have actually benefited on a relative basis as markets began to price in the prospects of a slower path of U.S. rate hikes as a result of lowered global growth expectations.
Importantly, we seek to ensure that we are adequately compensated for risk within the portfolio and to reduce the impact of exposure to risk factors that are not rewarded. For example, currency does not offer an inherent risk premium as compensation for volatility, so we currency hedge a portion of our international equity exposure. This allows us to benefit from investing in companies outside the U.S. without the same degree of currency volatility.
Q: What is your research process and how do you look for opportunities?
Our underlying portfolio managers, who are sector specialists in their segment of the market, work closely with a team of over 225 global research analysts in the security selection process. The portfolio managers look country by country to find attractive opportunities based on their fundamental view of companies and securities taking into consideration their competitiveness in global or local markets, current valuations, and economic factors such as growth, inflation, as well as policy expectations.
We believe the active management of these sector specialists in the security selection process is a differentiating factor in our investment approach, and one which is built upon our commitment to in-house fundamental research. The contribution of our proprietary research is particularly pronounced in areas such as international small-cap names which often are thinly covered by Wall Street sources or global banks, and which can provide an opportunity for us to add value through independent analysis.
Q: How do you construct the portfolio?
The first step is to select the asset classes and sub-asset classes to include in the portfolio and then to identify the underlying strategies or building blocks components to include in best meeting our investment objective.
Our approach to global allocation is defined by active management, and by the security selections made by sector specialists across our 20 different underlying strategies. They identify the securities with the most attractive risk-reward opportunities within their opportunity sets.
Second is the evaluation of how these components work together. We look not only at the attributes of long-term risk and return for each underlying strategy, but also at the correlations between them, specifically across a breadth of market environments. Our goal is to balance the portfolio’s growth objective with elements that can smooth the ride and efficiently moderate volatility.
The fund has a base allocation of 60% to equities. At the major asset class level – for example, between stocks and bonds – we can be overweight or underweight plus or minus 10%, so it can go up to 70% or down to 50%.
At the moment, we are neutral between stocks and bonds. Though we currently view equities as a bit rich to history we do not see fixed income as attractive given the environment of low-to-negative yields.
Our approach, as we look to overweight or underweight segments of the portfolio, is to favor areas we believe offer attractive relative valuations. In today’s low-growth environment many of the segments we invest in are at or above fair value.
Geographically, approximately half the equities in the portfolio are U.S. equities and half outside the country. Right now, we have an overweight to international equities, where we have found more attractive valuations.
However, we have been paring back that overweight. While central bank monetary policies outside the U.S. remain very accommodative, it is increasingly questionable whether these policies will spur economic growth and serve as a catalyst to an upswing in earnings.
In a low-growth environment with high implied volatility like we see today, our equity index call-writing strategy can do well. Within this strategy, we trade some of the upside of equities to harvest the variance risk-premium. This provides an alternative – and potentially consistent – source of return even when the market is not going up.
The fund’s benchmark is the Morningstar Global Allocation Index, which has 60% allocation to global equities and 40% to global fixed income.
Q: How do you define and manage risk?
Risk is a combination of factors that contribute to uncertainty as we seek to meet our investment objectives.
To control and moderate risk, we look at it in the design of the portfolio, our security selection, and the fund’s tactical positioning.
In the fund’s design, risk is mitigated through diversification – not just geographical diversification, but through the inclusion of strategies that help to either moderate the portfolio’s volatility or improve its performance in specific environments.
Within the security selection process, we seek to moderate risk by knowing what we own. Active management is an integral part of this.
So rather than buying an ETF with the same broad risk exposure as the market, we seek to gain an information advantage by working closely with sector specialists in the security selection process, and drawing on the insights of our global research analysts. This ensures we have confidence in the long-term return prospects of the company whether through a stock or bond investment.
In tactical positioning, where we overweight or underweight segments, one way we seek to control risk is by emphasizing relative valuation. This gives us a cushion that can improve the long-term return potential.
Rather than trying to chase a sector that has been a top performer in the past one to three months, we look out six to 18 months for attractively valued segments that have a catalyst to help realize that value.
