Managing Portfolio Risk in Times of Unprecedented Geopolitical Events

In the last few weeks, the war in Ukraine has increased the sources of uncertainty for the global economy, including the risk of possible new sanctions.

We recently reoptimised your portfolios to protect them in these uncertain times. Before we outline the changes to your portfolio, you may first want to know more about our investment framework, ERAA®, and why we’ve taken this decision.

First, here’s more on ERAA® and how it works

Studies have shown that the majority of returns come from asset allocation. And history has also shown that the economy, not the markets, ultimately drive returns over the medium to long term.

For these reasons:

• ERAA® determines asset allocation based on leading indicators of growth and inflation. These macroeconomic indicators inform us about the economic regime we’re in, and hence, the optimal asset allocation for each economic regime.
• We don’t engage in securities selection and refrain from actively-managed funds, instead opting for highly-diversified, liquid, and low-cost exchange-traded funds (ETFs).

This investment framework ultimately drives how we optimise your portfolio. We're deliberate and calculated in how we optimise allocations. Since our launch in 2017, we’ve reoptimised our portfolios 6 times - approximately once every 9 to 10 months - and generated average annual returns of 2.1% to 9.9%, depending on the portfolio’s risk level.

Learn more about how ERAA® works →

In exceptional circumstances, information may sit outside of ERAA®’s framework

For the first time since our portfolios’ inception in 2017, the risks arising from the war in Ukraine presented new information that wasn’t captured by global macroeconomic data. But that doesn’t mean that our investment framework is limited to these data points.

In unprecedented instances like these, our investment committee can supplement ERAA® by tactically allocating assets when new information becomes available. Tactical asset allocation is a necessary exception that allows us to maintain optimal risk-adjusted returns over the long term.

This is compared to a passive asset allocation approach, which would risk exposing our clients to increased risks during difficult macroeconomic environments.

Our goal is to manage wealth for the long term, and we’ll continue to use this learning to continually refine our investment algorithm.

About our recent reoptimisation

In view of the heightened asset volatility given the current uncertainties, here’s how your portfolios have been reoptimised:

We’ve minimised allocation to markets that remain at risk of secondary sanctions

The Russian invasion of Ukraine has set global geopolitics into disarray. While our portfolios had very limited exposure to Russia, they did have exposure to China. Currently, China remains at risk of secondary sanctions due to its close relationship and continued dealings with Russia.

• There is a higher risk that the US would weaponise the delisting of Chinese ADRs (American Depositary Receipts)
• There is also a higher risk that the US would deploy secondary sanctions to pressure China

As a consequence, we’ve seen increased volatility in China assets at levels that are significantly above the norm. This volatility increased the realised risk of our portfolios, which is why we’ve minimised direct and indirect allocations to Chinese assets with this reoptimisation.

The following chart shows KWEB volatility as a result of the growing geopolitical tensions.

(Source: Bloomberg)

We’ve increased allocation to asset classes with less sanction risk

Our investment framework has reallocated the capital released from the China divestments to other assets that have minimal direct exposure to sanctions risk, while considering the changes in relative valuation of the last few months.

• For our flagship global portfolios, depending on risk level, this reoptimisation has reduced your China exposure from 3% and 20% to 0.0% and 0.4%. In most cases, incremental allocation has gone to Australian and Japanese Equities, international treasury bonds, and international inflation-linked bonds.
• For our other offerings such as the ESG portfolios, we have ensured that China exposure is 5% or less.

We’re keeping a close eye on event risks and global economic trends, and recommend that you continue to maintain a long term perspective when it comes to investing: stick to an investment plan throughout the market ups and downs, maintain the appropriate risk-target, and dollar-cost average your investments over time.

Find out more about our previous reoptimisations that have helped protect your portfolios against rising inflation,first in the US, thenglobally. These reoptimisations have allowed our General Investing and Goal-based portfolios to outperform relevant benchmarks by 0.9% to 4.7% between 1 January and 22 March 2022.

*Our same-risk benchmarks are proxied by MSCI World Equity Index (for equities) and FTSE World Government Bond Index (for bonds). The benchmarks we use have the same 10-years realised volatility as our portfolios. We calculate these returns before fees, and all returns are in USD terms. The inception date for portfolios with SRI 6.5%, 8%, 10%, 12%, 14%, 16%, 18%, and 20% is 19 July 2017; the inception date for portfolios with SRIs of 26%, 30%, and 36% is 16 August 2018; the inception date for the portfolio with SRI 22% is 15 August 2019.

Past performance is not a guarantee for future returns. Before investing, investors should carefully consider investment objectives, risks, charges and expenses, and if need be, seek independent professional advice.

Frequently asked questions about this reoptimisation

Why is there an increase of IGOV and EMB despite rising inflation?

Even though inflation is at historical high, the bond market has also started to price inflation in via increases in interest rates, resulting in a fall in bond prices. In the short term, the economic outlook on Russia can increase volatility of individual assets. However, this reoptimisation focuses on the long term risk and return profiles from a portfolio perspective. On top of that, the portfolio will always utilise allocations to protective assets, such as government bonds, to achieve the desired overall risk level. These allocations ensure that if big, risky events happen, the portfolio can adhere to its chosen risk level.

Why did StashAway sell KWEB?

The risk that the US would deploy secondary sanctions to pressure China is significant. Additionally, the surge in volatility of China assets has raised the urgency of managing this unprecedented risk.

Why is StashAway only reopting out of KWEB now and not before?

This reoptimisation is out of the ordinary, in that it was the first time that our investment algorithm didn’t have all the information to drive investment decisions. This reoptimisation therefore looks beyond prices and valuations. The geopolitical risk and potential secondary sanctions on China have not only resulted in heightened volatility, but, if deployed, would also significantly impact our portfolios.

Why was KWEB sold in one go instead of in phases?

We executed the reoptimisation quickly due to unprecedented sanction risks. The nature of sanctions is that they can be deployed quickly by governments, and can critically result in having our assets frozen. This risk differs from the risk of falling prices, which would otherwise enable us to sell the asset in phases.

How much "human intervention" can we expect from StashAway moving forward?

As the risks arising from the war in Ukraine are extraordinary and unprecedented, we don’t foresee similar interventions. We firmly believe in investing for diversified portfolios for the long-term, where our framework adapts asset allocation according to macroeconomic conditions. However, the investment committee oversees this framework for risk management reasons, and can intervene when it doesn’t have all the information required to drive investment decisions.