Policy and Strategic Asset Allocation support

Client-Specific Concerns

The client, a Middle-Eastern financial institution, sought support for reviewing and creating its Shariah-compliant Investment Policy Statement (‘IPS’), Strategic Asset Allocation and risk management framework. The client was looking to build an investment portfolio that avoided annual drawdowns, while targeting a 7-8% annal return.

They engaged bfinance as an advisory partner to review their strategic investment plan, with a particular focus on their aspiration to achieve no annual drawdown. Beyond supporting the team’s SAA efforts, the engagement focused on policy documentation, including the development of IPS documents for various portfolios managed by the organisation and formulating appropriate risk policies, frameworks, and procedures such as manager selection procedures, covering specific requirements of public and private market strategies.

With this engagement, the client was ultimately aiming to robustly support their anticipated growth in assets under management.

Outcome

• Public equity risk dominance: Within the public market portion of the SAA, it was argued that public equity risk will form the largest risk to generating drawdowns, with other public asset classes such as Sukuk and Liquid Alternatives providing diversification.
• Overweight private markets: It was argued that private markets have the potential to reduce the frequency and depth of drawdowns generated by public markets and could thus form a large proportion of the portfolio to achieve the no annual drawdown objectives. In theory, the private market SAA would prefer strategies that 1) meet the 7-8% return target on a standalone basis, and 2) would reduce the frequency and depth of annual drawdowns.
• Selection framework for private asset classes: A qualitative evaluation framework for private market asset class/strategy selection was proposed in the absence of “hard” quantitative risk/return input. The framework considers parameters that are of importance to the client, such as expected return, income, drawdown risk and diversification effects. Qualitatively, such parameters are linked to the economic exposure that each asset class/strategy provides: growth capital, interest capital or mixed capital. The selection framework indicated that interest capital and mixed capital strategies are most suitable for the portfolio. Within each capital type, strategy selection would allow the investment team to finetune the exposure to match risk appetite.
• No drawdown aspiration: bfinance analysis showed that interest capital (e.g. private credit) strategies and mixed capital (e.g. core real estate) strategies have the potential to push the portfolio towards its no drawdown objectives. While drawdowns cannot be avoided entirely, analysis shows that a diversified private markets portfolio can reduce the frequency and severity of drawdowns greatly. A meaningful reduction in drawdown frequency on both an annual and quarterly basis is achieved from a 50% private markets allocation.
• Investment Policy Statement: With the aim of populating the organisation’s investment policy documentation, the project first considered setting out an appropriate investment framework, which outlines that the overall investment mandate, philosophy, approach to risk management and governance structure. The following Investment Policy Statement provides specific guidance on roles and responsibilities, investment objectives, investment constraints at the portfolio and asset class level. Given the organisation's governance structure it was decided to include the investment risk management framework in the IPS directly, highlighting how risk managed along with relevant escalation and cure procedures.