How to structure the Equity portion of an institutional asset allocation?
One of the questions most frequently asked by institutional investors is how to structure their asset allocation. The traditional model of segmentation between major asset classes – mainly equities, fixed income and diversification assets – leaves room for, or combines with, other approaches, based on end objective, macroeconomic factors (growth, inflation indexing or stress hedging) or level of liquidity, depending on the investor’s constraints. These questions are also raised with regard to the equity allocation of their portfolios, which can be structured geographically, by sector, or by factor. This article details our recommendations in this area, based on our experience in our asset allocation advisory business and the development of allocation solutions for institutional investors.
When investors buy equities they aim to capture:
- statically, for example via an equally risk-weighted combination between exposure to the size, quality, momentum and low volatility factors;
- or dynamically, to tap into the differences in behaviour of these factors, based on the position in the economic cycle2.
Alpha, which can be found in:
- A tactical allocation between countries, factors or investment styles. This allocation can be:
implemented by the investor himself/herself;
in the form of a selection of global equity funds managed actively based on a top-down approach, with extensive tracking-error to have an impact on the allocation’s performance;
be delegated to one or more allocation managers via overlay mandates; to work properly this option requires transparency on the various components of the investor’s portfolio.
The next question to address is on allocation between these four sub-portfolios, which, for simplicity’s sake we will call beta, smart beta, alpha and Illiquidity. The answer depends on many parameters, such as:
Regarding implementation, the choice between dedicated mandates and open-ended funds will depend on the amount of assets invested and the institution’s constraints in terms of reporting and resources that can be devoted to adjusting and monitoring investments.
To limit long-term non-financial risks, an ESG filter can be used to select stocks in the portfolio, based on a process ensuring low tracking-error against standard benchmarks. Likewise, investors aware of the structural risks incurred from climate change may, in addition to measuring their portfolios’ carbon footprint, set up a filter excluding the heaviest polluters and/or invest opportunistically in sustainable assets.
Diversifying sources of performance, structuring equity portfolios between beta, smart beta, alpha and illiquidity, and integrating climate risk should therefore serve as keys to structuring an equity portfolio.
 T. Roncalli, “Alternative Risk Premia: What Do We Know?”, Amundi Working Paper, April 2017
 See also A. Russo, “Equity Factor Investing according to the Macroeconomic Environment”, Amundi Discussion Paper, November 2015
Chief Allocation Advisor
Gross performances of our strategies (May 31st, 2017)
Amundi, data as at end of May 2017. Gross performance of “Balanced Institutional Absolute Return Low volatility “, Multimanager Multi-Asset Fund of Funds (Bonds)“ GIPS composites in euro. Their respective benchmarks are: Eonia capitalized and a composite benchmark: 50% JPM EMU Government Bond Index, 30% JPM Government Bond, 20% Exane ECI – Europe Convertible. Past performance is not a reliable indicator of future results or a guarantee of future returns.