All of these managers make allocation shifts in their funds, but the rationale, timing, and extent of their shifts vary. The asset-allocation committee at T. Rowe Price, headed up by Rich Whitney, has made successful tactical shifts in various funds since 1990. The team oversees the tactical positioning in the T. Rowe Price Retirement target-date funds, which have a Morningstar Analyst Rating of Gold, as well as in the firm's Silver-rated Personal Strategy and Spectrum funds. JPMorgan also has an experienced allocation group that implements tactical shifts in the firm's Silver-rated JPMorgan SmartRetirement target-date funds. Both the T. Rowe Price and JPMorgan teams rely primarily on the long-term strategic allocations of their funds, using small tactical adjustments to supplement returns.
Our list also includes GMO's Ben Inker, who has run Silver-rated GMO Global Asset Allocation (GMWAX) since 1996, and BlackRock's Dennis Stattman, who has led Gold-rated BlackRock Global Allocation (MDLOX) since 1989. These two managers pay particular attention to valuations at the asset class and individual security level, and they have ample freedom to differentiate their portfolios from their benchmarks. Lastly, we think highly of Rob Arnott at Research Affiliates, who has subadvised Gold-rated PIMCO All Asset (PASDX) and Silver-rated PIMCO All Asset All Authority (PAUDX) since 2003. (The latter makes use of leverage, while the former does not.) Arnott has no predefined benchmark allocations but instead aims to beat inflation by 5% annualized for All Asset and 6.5% annualized for All Asset All Authority over a market cycle investing across all segments of the market.
The Big Picture: Stocks vs. Bonds
For two of our favorite asset allocators, the call on stocks is a straightforward relative value decision. As of Dec. 31, 2012, both T. Rowe Price and JPMorgan have tilted their portfolios toward equities and away from bonds. T. Rowe has a slight 2% overweighting to stocks and a 2% underweighting to bonds across its allocation funds. The firm's allocation team believes stocks trade at reasonable valuations but appear more attractive than the unfavorably low yields offered by bonds. JPMorgan's allocation team has a roughly 4.5% overweighting in stocks in its target-date funds and a 4.5% underweighting to its fixed-income target weight. The team believes there is a global economic recovery that has created a favorable environment for equities.
Unlike the target-date series, BlackRock's Dennis Stattman and GMO's Ben Inker can be more flexible by holding cash or alternative strategies. Stattman positioned his fund with a slight 1.6% overweighting to stocks relative to his benchmark's 60% stake at the end of 2012. But he has a substantial underweighting in bonds, holding 24% of the fund's assets there compared with the benchmark's 40% weighting, reflecting his concerns about the bond market's low yields. The fund has a 14% cash-equivalents stake, which Stattman uses as a source of ballast and dry powder for when more attractive opportunities arise. His team also uses that stake to manage the fund's currency exposure. Similarly, Inker has an underweighting to both equities and bonds, but with a substantially more negative view on bonds. His fund's 13% stake in fixed-income is well below its benchmark allocation of 35%, while the portfolio's 60% equity stake is slightly below its benchmark's 65% weighting. Inker doesn't find today's bond yields attractive but also isn't bullish on stocks given the firm's view on equity valuations. Instead he holds a hefty 18% stake in the firm's long-short equity strategy, GMO Alpha Only (GAPOX), as a source of assets for when market conditions change.
Rob Arnott takes a decidedly different approach. His focus on current yield as a valuation metric often leads to a net equity exposure below 30% of assets. At the end of 2012, PIMCO All Asset held nearly 70% of its assets in bonds, while PIMCO All Asset All Authority maintained a 60% stake. Arnott has concerns about rising interest rates similar to the other managers, which is why most of his bond exposure comes from high-yield and emerging-markets bonds. In both funds, Arnott has reduced the Treasury Inflation-Protected Securities allocations over the past year, as he finds the securities too expensive. For All Asset, this has led to increasing the equity stake to 19% of assets from 13% at the beginning of 2012. In All Asset All Authority, the fund has a 4% net short position in stocks because of Arnott's unfavorable view on equity yields.
Not All Equities Look Great
While several of our Gold- and Silver-rated allocation managers favor stocks over bonds, they are particular about which stocks to own. Both T. Rowe Price and JPMorgan favor large-cap equities over small-caps, as they believe small-cap stock valuations are too high. In fact, the small-cap Russell 2000 Index has a price/earnings ratio that indicates that it is trading near its all-time high relative to the large-cap Russell 1000 Index, as of December 2012. Inker also leans toward large-cap stocks but goes a step further by preferring high-quality large-cap companies. These businesses have low debt levels and stable profitability that should help them perform well in challenging market environments.
Most of these managers also find foreign stocks more attractive than domestic equities. In regards to foreign developed markets, JPMorgan’s allocation team likes European stocks excluding U.K. equities for their cheap valuations relative to other developed markets. Inker at GMO also finds some developed markets attractive, as he has found relatively cheap equity valuations in Europe and Japan. Stattman also likes the valuations of Japanese equities, allocating 7% of the fund's assets there. He believes the market overly sold off Japanese stocks and that the country's recent fiscal and monetary reforms will help its economy.
Many of the managers have favorable views on emerging-markets stocks. Both JPMorgan and T. Rowe Price have long-term biases toward emerging-markets stocks over developed markets, as the firms like the growth prospects and economic fundamentals of emerging markets. Arnott also has been attracted to the higher expected growth rates of emerging markets. In both of his funds, he invests nearly all of the equity positions overseas, with roughly half that stake in emerging markets.
Not All Bonds Look Bad
Most of the managers have low expectations for bonds, particularly U.S. government-related debt, but they aren't ruling out all fixed-income securities. In general, the managers favor bonds with greater sensitivity to credit risk and lower sensitivity to interest-rate changes. T. Rowe Price has a slight 1% overweighting to high-yield bonds and a 1.5% tilt toward emerging-markets debt. The firm expects U.S. corporate default rates to remain low and believes the fiscal status of emerging-markets countries is more favorable than in developed markets. JPMorgan also leans toward high-yield bonds in its portfolios, but the firm has a neutral position in emerging-markets debt. JPMorgan's allocation team has concerns about the rapid flow of money into emerging markets over the past few years. Inker has minimal bond exposure in his fund, but most of his small allocation is in higher-yielding bonds and emerging-markets debt.
Arnott invests in similar securities to the other managers but has substantially more-pronounced allocations. In both All Asset and All Asset All Authority, he splits the fixed-income weighting roughly in half between credit-sensitive strategies, such as high-yield bonds and bank loans, and emerging-markets debt and currencies. He finds that these segments of the market continue to offer decent yields relative to other parts of the bond market, even after the yields have fallen over the past several years.
Making tactical allocation shifts is a tricky business, as it requires both foresight and patience. These managers have shown over long periods of time that they can add value through tactical shifts. Understanding the views of these top allocators can help set expectations for investors, even if investors aren't tactically moving their portfolios. For instance, the managers' uniformly negative stance on U.S. government-related debt suggests that investors may want to be mindful of that area of their portfolios. For the more tactically inclined investor, as several of these managers make clear, it may help to remember that cash and other liquid securities can become an attractive asset class when the market doesn't offer many clear bargains.