Our process for using market signals to help fine-tune risk exposures in multi-asset class funds is both sophisticated and tactically efficient. I’ll elaborate with an actual example that recently went full circle.

The goal: Increase exposure to Japan

Analysis from our global team of investment strategists shows that the Japanese equity market has successfully staged a comeback. They summarized this trend in the team’s latest quarterly report Asia-Pacific outlook:

Getting Japan back onto a convincing growth path, after two lost decades, has been a long journey. The evidence is now starting to build around a real reacceleration. Improvements are being driven by short-term stimulus effects such as lower energy prices, a weaker yen, and resolute Bank of Japan (BoJ) action.

Seeing early signs of what was unfolding in Japan, particularly with the rise of Shinzō Abe to prime minister in late 2012, we made the tactical decision to overweight Japan relative to its percentage of the global equity market. An investment manager running a conventional hedge fund strategy or a global tactical asset allocation fund would probably have chosen to “go long”—buying Japanese equities to reach the desired allocation. However, this approach might result in buying positions that actually offset other positions in their existing portfolio, or ignoring other risk exposures.

At Russell Investments, we’ve designed a sophisticated risk platform that allows us to look at our sub-advisors’ portfolios in real time. It aggregates the exposures to various risk factors, and then we use this information to make tactical investing decisions—within strictly defined parameters—that we believe will add value.

In this case, we saw that our sub-advisors had systematically underweighted Japan. Why? For two decades that market had been dead money. There had been too many false signals, too many disappointments over the years. Yet, we saw value.

Precisely calibrated risk factors

First, we bought futures based on the Tokyo Stock Price Index for passive stock market exposure to Japanese equities. That move gave us immediate exposure to the market; but with structural changes forthcoming, we also wanted an active manager to sift through the opportunities and risks. For instance, with the Japanese yen set to fall, differentiating between export companies likely to benefit from a falling yen and importing companies more likely to be hurt could add significant value. With the immediate market exposure in hand, we had breathing room but needed to hire a Japan-only active investment manager to give us the long equity exposure we’d have confidence in.

Thanks to Russell Investment’s global reach, we have consulting, research, and funds operations in Japan to serve our clients in the country. While not many U.S.- or Europe-based clients use Japan-only funds, it’s a key product in the Japanese market (just as UK-only equity funds are important in the British domestic market, and so forth). As a result, we already had deep manager research in place with an experienced Russell Investments’ portfolio manager. So it was simply a matter of transitioning from the futures to the long exposure.

When managing a global multi-asset portfolio, it’s also part of our policy to separate the decision about currencies from the decision about equities. We have the ability to analyze and manage them separately and, in this case, we made the tactical decision to hedge the yen exposure.

Of course, the important thing to remember about such dynamic, shorter-term tactical moves is that they always are executed in relation to the preferred positioning of the fund’s strategic asset allocation. In this example, we shifted the allocation to Japan back to neutral in mid-June 2015 and locked-in some market gains. Our overweight to Japan for that two-and-a-half-year period coincided with a 120% return for the Japanese equity market, compared to 55% for U.S. equity and 47% for European equity.1

That’s a quick review of how our team leverages capital markets insights to fine-tune exposures in multi-asset funds. Some of those ideas come from our strategy team’s market outlook views, such as the insights offered in their latest quarterly report: 2015 Global Outlook – Q3 Update.

1 Period from Nov. 30, 2012 through June 18, 2015, based on returns from the Nikkei 225 stock index of Japanese stocks, the S&P 500® index of U.S. stocks and the EURO STOXX 50 index of eurozone stocks.

Disclosures

These views are subject to change at any time based upon market or other conditions and are current as of the date at the top of the page. The information, analysis, and opinions expressed herein are for general information only and are not intended to provide specific advice or recommendations for any individual or entity.

Investing involves risk and principal loss is possible.

Forecasting is inherently uncertain and may be incorrect. It is not representative of a projection of the stock market, or of any specific investment.

Investments in non-U.S. markets can involve risks of currency fluctuation, political and economic instability, different accounting standards and foreign taxation.

Japan’s Nikkei 225 Stock Average is a price-weighted index comprised of Japan’s top 225 companies on the Tokyo Stock Exchange. The Shanghai Composite Index tracks the biggest and most important public 991 companies in China as of June 18, 2015.

The EURO STOXX 50 is a stock index of eurozone stocks designed by STOXX, an index provider owned by Deutsche Börse Groupand SIX Group.

The S&P 500®, or the Standard & Poor’s 500, is a stock market index based on the market capitalizations of 500 large companies having common stock listed on the NYSE or NASDAQ.

Standard & Poor’s, S&P, and S&P 500 are registered trademarks of Standard & Poor’s Financial Services LLC (“S&P”), a subsidiary of The McGraw-Hill Companies, Inc.

Russell Investments is a trade name and registered trademark of Frank Russell Company, a Washington USA corporation, which operates through subsidiaries worldwide and is a subsidiary of London Stock Exchange Group.

Copyright © Russell Investments 2015. All rights reserved.

This material is proprietary and may not be reproduced, transferred, or distributed in any form without prior written permission from Russell Investments. It is delivered on an “as is” basis without warranty.

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