Asset Allocation Process
Asset allocation is the process of investing a portfolio across a variety of different types of assets such as shares, property or fixed interest. The price of each of these asset types behaves differently in different market conditions. They do not all rise or fall together. This offers a way of managing risk and return in the portfolio by holding a proportion of the investments in each type of asset. This is called diversification or "not putting all your eggs in one basket".
The decision about the proportions that are held in each asset type or class is very important. Portfolios with different asset allocations will have significantly different returns over time. Independent academic studies over the last 30 years have shown that more than 80% of the difference in returns on portfolios can be explained by the difference in their asset allocations, whereas variations in the weightings to individual investments within each asset class were shown to deliver about 10% to 20% of the variations in portfolio returns.
How do we do it?
- We are not limited in our thinking. We don't need to consider competitors' positions, or the extent to which investment performance will affect product inflows as has been the case with the Funds Management industry for many years.
- We set long term strategic asset allocation benchmarks and ranges are set for each Portfolio using asset class return forecasts of returns over the next ten years - for a number of economic and financial market scenarios.
- Then, on an ongoing basis we assess these asset class prices against their long term fair value. Fair Value is the price at which as asset achieves the long term Required Rate of return (RRR). The RRR is the return needed on an asset to compensate for its risk, relative to the rate attainable from long term Government bonds.
- From these assessments, the proactive portfolio asset allocation weightings are then derived. The further the asset class is away from fair value, the greater the shift away from the long term benchmark asset allocation.
