Secular evolutions in response to a changing market environment
Waddell & Reed Advisors Asset Strategy Fund - October 2011
Below, co-portfolio manager Mike Avery reviews how the Fund has evolved — while being guided by a consistent philosophy — over the last 15 years.
Since the beginning of our time managing the Waddell and Reed Advisors Asset Strategy Fund in 1997, we have been focused on seeking investments with the potential to capture high total returns, while also seeking to preserve capital by managing downside risk. With no set allocation mandates to limit our flexibility, the Fund’s broad purview enables us to look across a variety of asset classes: stocks, bonds, cash, precious metals, derivatives and currencies, without geographical, capitalization or asset class constraints. The flexibility of the Fund is a key element of our approach and allows us to apply global research toward pursuing the best opportunities. Unlike many “world allocation” funds that include allocation mandates, our go-anywhere capability allows us to pursue a greater variety of potential opportunities. Over the years, this has enabled us to move into different investments and geographic areas as changes in demographics and markets and political and economic events reshaped the global market. Since January 1997, we have made five strategic, significant shifts in the structure of the portfolio.
In the beginning
In the late 1990s, we were focused on the developed world — primarily U.S.-centric securities, with a tilt toward technology, media and telecommunications. These were the sectors we thought offered the most compelling growth opportunities that we could identify at that time. The portfolio maintained this U.S.-centric exposure until late 1999. Here’s a look at how the Fund was allocated during this period. As you can see, through most of this period the Fund held a high allocation to U.S. equity securities.
Allocation ranges reflect positioning at the end of each quarter over the period indicated on each table. Risk management tools such as futures and options are generally included in the cash line. USD equals U.S. dollar-denominated.
Moving through the tech wreck
In early 2000, at the peak of enthusiasm for U.S. equities, we began to reduce the portfolio’s equity exposure and moved into fixed-income securities as a hedge against equities. By 2001, the Fund had substantially reduced exposure to equities, with approximately 70 to 80 percent of investments in fixed-income securities. This served clients very well at that time, as U.S. equities progressed through a severe bear market. At the time, you could have said that Asset Strategy was more akin to a fixed-income fund, rather than an equity fund, and certainly not a world allocation fund. Consistent with our broader philosophy, given the choices available to us and the macro-economic environment, we determined this was the best place to be for our investors.
Growth skepticism coming out of recession
In early 2003, the U.S. economy was coming out of a recession, but skepticism about growth was still very high. Everyone was trying to determine where the world would find growth. Our investment team began to think less about which specific markets or countries to invest in and began thinking more about the world in terms of where people were enjoying rising prosperity. From 2003 to 2007, we focused on the infrastructure build-out taking place in Asia, capitalizing on the rising demand for materials, energy and industrials. To some, the Fund may have looked similar to a natural resources fund at that point. The reason we were focused on those areas at that time was because we had the flexibility to do so, and that’s where we felt the best opportunities were.
Amidst the financial crisis
As 2006 rolled into 2007, we began to use derivatives as an asset class to hedge the portfolio in a more meaningful way. Even though we continued to like materials, energy and industrials, based on the infrastructure boom that was occurring in Asia, the prices of those securities began to reach a point that we determined was too high, despite the underlying growth drivers and still-high enthusiasm for equity exposure in the market. While our focus was still very much on China and energy, it made sense to us then to use derivates as a way to mitigate the systemic risk exposure of the Fund. We think this was a wise move, as derivatives were very cheap at that time and given the strength of the urbanization and infrastructure build-out that was underway in Asia. This strategy worked well for shareholders until July 2008. As we moved through the crisis it became clear that cash would be the preferred way to protect investors. The Fund’s cash allocation rose to levels above 45 percent and stayed very high.
A Focus on emerging consumption
In the uncertain market environment that characterized much of 2008, we expanded our focus beyond urbanization and infrastructure build-out occurring in emerging markets to the domestic consumption sectors — those areas where, as people enjoy rising prosperity, they are likely to spend more money on things such as consumer goods, entertainment, financial services, technology and transportation. That’s how we’ve structured the portfolio to this point. Once again, we see an environment in which disbelief of growth and a very high level of risk aversion dominates markets and creates what we believe to be the mispricing of securities. This combination of factors has led us to increase the Fund’s equity weighting and focus on the companies that we believe are attractively priced and well positioned to participate in thematic growth.
These secular and, in our view, strategic and responsive changes to the portfolio over time, are a key element of why the Fund has earned the track record it has. Our mandate – to capitalize on opportunities across a variety of asset classes: stocks, bonds, cash, precious metals, derivatives and currencies, and without restriction — has not changed. We believe that flexibility is at the core of our process and while the portfolio is always evolving, the process that builds the portfolio is fundamentally unchanged. To be sure, recent months have brought more volatility to the market as a whole, and the portfolio has not been immune to that. We believe that in the future Fund shareholders will be compensated for taking on volatility in an environment in which we think extreme risk aversion has driven up the price of assets that are perceived to be safe and has driven down the price of assets that would participate in future growth. As it should, the portfolio has evolved and adapted to the market environment. What has stayed constant is our mandate and our strict focus: on researching all markets and asset classes, identifying what we feel are the best investment opportunities, managing risk, and, ultimately, doing what is in the best interest of our shareholders.
Past performance is not a guarantee of future results. The opinions expressed are those of the Fund’s managers and are not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through October 14, 2011, and are subject to change due to market conditions or other factors. The S&P 500 is an unmanaged index that tracks the stocks of 500 primarily large-cap U.S. companies.
Risk factors: The Fund allocates from 0–100 percent of its assets primarily among stocks, bonds, and short-term instruments, across domestic and foreign securities. International investing involves additional risks, including currency fluctuations, political or economic conditions affecting the foreign country, and differences in accounting standards and foreign regulations. These risks are magnified in emerging markets. With regards to fixed-income securities in which the fund may invest, these are subject to interest rate risk and, as such, the net asset value of the fund may fall as interest rates rise. Because the Fund may concentrate its investments, the Fund may experience greater volatility than an investment with greater diversification. The Fund may use short-selling or derivatives to hedge various instruments, for risk management purposes or to increase investment income or gain in the Fund. These techniques involve additional risk. Investing in physical commodities, such as gold, exposes the Fund to other risk considerations such as potentially severe price fluctuations over short periods of time. These and other risks are more fully described in the Fund’s prospectus. Holdings information is not intended to represent any past or future investment recommendations. Holdings and allocations can and do change frequently.
Investors should consider the investment objectives, risks, charges and expenses of a fund carefully before investing. For a prospectus, or if available a summary prospectus, containing this and other information for the mutual funds offered by Waddell & Reed, call your financial advisor or visit us online at www.waddell.com. Please read the prospectus or summary prospectus carefully before investing.