Asset allocation is the current investment buzzword.
Strategic asset allocation is considered by many to be the only true form of asset allocation. It means owning a diversified portfolio of dissimilar assets that provide an investor with the highest expected long-term return for the investor’s preferred risk level. Tactical asset allocation is more dynamic and emphasizes short-term returns and is often equated to market timing. A classical market timer moves the portfolio in and out of the market, so it is, he hopes, fully invested during rising markets and out of the market when prices fall. The evidence on investment managers success with market timing is not very impressive and, in reality, overwhelmingly negative. Studies have shown that portfolio performance is driven 91.5% by asset allocation, enhanced to 93.2% by market timing, and further to 97.8% by security selection. But for most investment managers, portfolio management is neither art nor science. It is instead a very special problem in engineering, of determining the most reliable and efficient way of reaching a specified goal, given a set of policy constraints, and working within a remarkably uncertain, probabilistic, always changing world of partial information and misinformation, all filtered through the inexact prism of human interpretation.
So how does one design an investment portfolio?
Here are four steps:
- One must decide which asset categories are to be used.
- One must determine the long range target percentages of the portfolio to allocate to the specific asset categories.
- One must specify the range within which each asset category can be altered to increase performance.
- One must select securities within each asset category.
Diversification
We are proponents of modern portfolio theory, which is in laymen’s terms a lofty way of saying we believe in informed diversification. We seek to diversify through the use of asset allocation models. We also attempt to diversify risk, so that not all of a client’s assets are exposed to uniform types of risk. Diversification allows us to take advantage of a variety of markets through a broad range of investment opportunities. We never chase the highest returns but try to protect a client’s asset base while assisting. In the accumulation of liquid assets through investment opportunities which have historically produced above average returns with below-average risk exposure. However, past performance does not guarantee future returns, and we do not and cannot guarantee portfolio performances.