Agenda Module 1 - Risk, Volatility & Timescale Module 2 - Asset Allocation Module 3 - Identifying the Building Blocks Module 4 - Reviewing a portfolio
Asset Allocation
Asset Allocation Definition Asset allocation is an investment strategy that aims to balance risk and reward by apportioning a portfolio's assets according to an individual's goals, risk tolerance and investment horizon. - Investopedia
Asset Allocation Strategic A fixed asset allocation which is determined by long term back-testing, and which does not take a view of markets’ current behaviour or short-term outlook.
Asset Allocation Tactical A fluid asset allocation which takes account of recent market movements, and the investor’s perception of the short-term outlook. It seeks to take advantage of perceived opportunities in the short term.
Asset Allocation Impact on portfolio Much disputed Contribution to variance of returns between 25% and 100% Being in the market is probably the biggest factor
Asset Allocation Impact on portfolio “About three-quarters of a typical fund’s variation in time-series returns comes from general market movement, with the remaining portion split roughly evenly between the specific asset allocation and active management” Ibbotson et al, The equal importance of asset allocation and active management
But Ibbotson and Kaplan also extended their research to consider asset allocation’s impact on the variation of returns among funds and the level of a typical fund’s return. They found that only about 40% of the return variation between funds is due to asset allocation, with the balance due to other factors, including asset- class timing, style within asset classes, security selection, and fees. And because the average of all investors is the market itself, with good managers and bad ones cancelling each other out, Ibbotson and Kaplan concluded that asset allocation ultimately accounts for 100% of the absolute level of returns. CFA Institute blog “Setting the record straight on asset allocation” 16/02/12 (emphasis mine)
Investment returns
Investment returns Contributing factors Market timing Market returns Stock/Fund selection (Active management) Asset Allocation
Investment returns Market Timing
Investment returns Market Timing
Investment returns Contributing factors Market timing Market returns Stock/Fund selection (Active management) Asset Allocation
Asset Allocation Reducing Risk Diversification across: Geographies Asset Classes Easiest way to diversify
Asset Allocation High Level Four main asset classes that matter: Equities (Shares) Alternatives Bonds Cash
Asset Allocation My suggestion Strategic, Long Term AA - Good Tactical, Short Term AA - Impossible for amateurs
Asset Allocation Some caveats There is no ‘correct’ asset allocation These are my examples I am NOT an economist/fund manager!
Asset Classes
Asset Allocation 10% Balanced example 50% Equities Bonds Alternatives Cash 40%
Asset Classes Equities (Shares) Small slices of a company Give voting rights and dividend income Can be volatile A very broad church
Size matters
Geography matters Currency matters
Asset Classes Bonds (Fixed Income) Loans to governments and to companies Most traded asset class globally Produce income, but usually lower growth A very broad church (again)
Asset Classes Bonds (Fixed Income) Low Yield / Low Risk Investment Grade Quality Yield Junk Bonds High Yield / High Risk
Asset Classes Alternatives • Property • Hedge Funds • Infrastructure • Private Equity • Commodities • Anything else!
Some sample allocations
Asset Allocation 10% 20% 5% Cautious example Equities Bonds Alternatives Cash 65%
Asset Allocation 5% 5% Mod Cautious example 35% Equities Bonds Alternatives Cash 55%
Asset Allocation 10% Balanced example 50% Equities Bonds Alternatives Cash 40%
Asset Allocation 10% Mod Adventurous example 20% Equities Bonds Alternatives Cash 70%
Asset Allocation 10% Adventurous 10% example Equities HY Bonds Alternatives Cash 80%
Asset Allocation Moderately Moderately Cautious Balanced Adventurous Cautious Adventurous 5% 10% 10% 10% 10% 5% 20% 5% 10% 35% 20% 50% 40% 70% 55% 80% 65% Equities Bonds Alternatives Cash
Asset Classes Mapping • Over 5 years • Using indices • Charge of 1% per year • Rebalancing quarterly • Strategic AA only!
Mapping
Mapping
Mapping
Asset Allocation Moderately Moderately Cautious Balanced Adventurous Cautious Adventurous 5% 10% 10% 10% 10% 5% 20% 5% 10% 35% 20% 50% 40% 70% 55% 80% 65% Equities Bonds Alternatives Cash
Asset Allocation Moderately Moderately Cautious Balanced Adventurous Cautious Adventurous 2% 9% 2% 5% 5% 5% 10% 13% 5% 18% 5% 20% 3% 3% 5% 5% 5% 15% 10% 15% 15% 15% 10% 26% 5% 37% 25% 40% 55% 52% 60% UK Equities Overseas Equities Bonds HY Bonds Property Commodities Cash
Summary Strategic vs Tactical Allocation Pretty much the only thing you can control Asset allocation reduces risk High-level and sub-level allocation There is no ‘right’ allocation
Look at other allocations on different sites
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