Strategic Asset Allocation

Client-Specific Concerns

The client, a Middle Eastern insurance company, sought to refine its Shariah-compliant strategic asset allocation (SAA). The SAA is positioned conservatively, and the investment team is mandated to maintain a tail risk buffer. The project set out to quantify the current buffer, and thereby scope out the potential for additional risk taking. Beyond long-term strategic risk/return dynamics, the team requested a detailed analysis of short-term risk behaviour of the newly devised SAA. Furthermore, the SAA must comply with various constraints, such as minimum liquidity, minimum local exposure, maximum non-local currency exposure and local regulatory (solvency) asset admissibility criteria.

Outcome

• Forward-looking capital market assumptions: The client expressed a desire to incorporate their views into the capital market assumptions. Throughout the engagement, the assumptions were tailored to the client’s situation, such as altering cash assumptions to be reflective of the team allocating to longer-term fixed rate deposits. Expected return from existing deposits was modelled at 4.7% p.a., while the long-term return on new cash deposits is lower at 2.2%, reflecting an anticipated lowering of interest rates.
• Optimisation analysis: Beyond risk/return dynamics, the optimisation considered insurance-specific parameters such as asset class admissibility criteria and investment constraints. Examples include maxima of local and international equity, alternative funds, financial institution exposure and non-local currency exposure.
• Prudently adding risk: The refined SAA reallocated from cash to sukuk (bonds) and private debt, taking advantage of the high interest rates and the potential for duration to diversify in adverse markets environments. Detailed analysis showed that the new SAA remained within predetermined downside risk buffers: the main buffer is defined as a function of Annual 5% Value-at-Risk of the SAA, the assets under management and expected trading results of the insurance business.
• Detailed historic analysis: In addition to forward-looking analysis, the project assessed historic performance to learn more about its long-term risk/return profile and the potential for short-term weakness that the SAA could produce. The updated SAA has returned 3.8% per annum since January 2008 up to November 2023, but with the expected return of 4.1% over the next 10 years. Volatility since January 2008 is 4.1% per annum, in line with the 10-year forward-looking expected volatility of 3.9%. During the ’08 GFC, the SAA generated a maximum drawdown of -15.7%, but recovered within 6 months due to the large sukuk holding. Since then, the next maximum drawdown of -4.2% occurred during the ’22 Inflation Scare.

Expected cumulative retuurn for the updated SAA