CIO Insights: A path to an optimized portfolio

“By diversifying, you will be able to achieve much higher returns for the kind of risk you are willing to accept. This is why we say diversification is the only free lunch in finance.”

Min Lan Tan, Asia Pacific Regional Head, Chief Investment Office, UBS Wealth Management

The past year has proved eventful for global financial markets. While the major economies have recovered to varying degrees, investor confidence has succumbed to policy uncertainty and disappointments. In 2014, some of the issues investors have faced will remain in play, as the following articles on the US fiscal debate and Japan’s ‘Abenomics’ explore. Here, Min Lan Tan talks about the overall investment environment and how clients can optimize their portfolios in the year ahead.


Global events kept markets on edge in 2013. What should investors watch out for in 2014?

The first would be the Federal Reserve’s tapering of monetary stimulus, which will have an impact on risk assets globally. We also think 2014 will be the first in four years that the world economy will reaccelerate to trend growth, though much of the rebound will come from developed markets. Activity indicators in Europe and Japan are improving, so growth will no longer be confined to the US. We also see very little sign of inflation anywhere, so risks associated with inflation will not be high. For emerging markets, differentiation is key. The more export-oriented economies will likely benefit from the recovery in developed markets, whereas the ‘twin deficit’ countries will be at risk of volatility and reversal in foreign capital flows as the Fed tapers.

What would be the best way for investors to manage their portfolios?

Making money through investment requires understanding one’s emotional and psychological makeup, so Strategic Asset Allocation (SAA) – the mix of asset classes and regions you invest in over the long term for your chosen level of risk – is essential. When you have a thorough assessment of your risk profile, you can create an optimal asset allocation for a five- to seven-year horizon, or roughly one business cycle. Staying invested throughout the cycle, which allows for the compounding of returns, and proper diversification are key to doing well.

Once you have an SAA, the next thing is to take advantage of short-term market fluctuations and opportunities. This is where Tactical Asset Allocation (TAA) comes in. From our perspective, TAA, where you execute short-term deviations from the SAA, has a six-month horizon and should not jeopardize your long-term investment goals, so it needs to be implemented with due attention to managing risk.

Do Asian investors follow this investment approach?

Asian investors tend to have a strong home bias. There is nothing wrong with this per se, but overconcentration affects performance. Diversification does not mean putting together a bunch of securities hoping you will lose less during times of market stress, or making less during an upswing. It is finding the right mix of securities that allows for higher returns at any given level of risk, or lower risk for a given level of returns.

A lot of clients also go for single securities. In these cases, risk – essentially the volatility and maximum potential drawdown during times of stress – can be significant. By diversifying, you will be able to achieve much higher returns for the kind of risk you are willing to accept. This is why we say diversification is the only free lunch in finance.

How would you convince Asian investors to diversify?

The profit cycle of Asian companies now is inferior to that of companies in developed markets. Costs in Asia have ramped up; even if revenue growth starts to rise, earnings will likely lag because of the labor, policy, and asset-price pressures. In developed markets, unit labor costs have fallen rapidly, asset prices are low, and central banks continue to run very loose monetary policy. When growth occurs in these markets, corporate earnings upgrades will be rapid.

Many investors will remember that when Asia was coming out of the 1997 financial crisis, asset prices were low and excess capacity was prevalent. That was a tremendous time to invest in the region. This experience is now being replicated in the developed markets, so this is the window for Asian investors to look outside the region.

Which markets would be good for Asian investors seeking to diversify?

A good destination is the US where the recovery is looking more entrenched. We continue to see opportunities in US high-yield bonds and US equities such as technology, real estate, mid-caps, and financials. Europe, which is starting to come out of recession, is also a good place to be. Given that cyclical sectors make up 41% of the Eurozone’s market cap, the improved global economic outlook and earnings growth trends should bode well for Eurozone equities – especially companies that can consistently increase their profits, as well as select banks. For Japan, meaningful policies are now in place to support a reflation of the economy, and positive earnings surprises will continue to underpin the market. One interesting theme for Asian investors is the recovery in Japanese companies’ capital spending.

Coming from investment banking, how would you describe investing for institutional and individual investors?

Investing requires passion and commitment. Institutional clients do that as a career, whereas individual clients may not have the bandwidth to constantly watch their portfolio and manage risk. Because institutional investors tend to be more systematic and embrace the broader principles of diversification and compounding, they also tend to achieve higher returns for any level of risk. For individual investors who may not have the same amount of passion and time to commit, quality advice is important to doing well.

What can clients expect from UBS in terms of wealth management advice in 2014?

We are in the midst of rolling out SAA strategies catered to Asian investors based in the Singapore dollar, the Hong Kong dollar, and the Japanese yen. Also, in light of the rapid growth we are seeing in Japan, Taiwan, and our Asian business in general, we are further beefing up the Chief Investment Office to better support clients in the way they think of their strategic and tactical asset allocation positions.