Asset allocation is chiefly driven by each client’s investment policy. Understanding the financial priorities of the client is paramount in determining the appropriate mix of asset classes. In developing a long range plan, we undertake steps to determine client liabilities (i.e. cash flows needs of the organization) and match the appropriate asset type against those liabilities. We use cash and equivalents to hedge cash flow needs within 2 years; bonds and other fixed income investments are used for liabilities between 1 and 7 years, while equities and other growth assets will be used to fund liabilities in excess of 5 years. So, it is the client’s individual spending needs and liquidity requirements that drive the strategic investment allocation for their portfolio.
All studies on this topic agree: asset allocation explains the preponderance of portfolio total returns. Indeed, on average over 70% of a discreet equity’s return over the course of a given year is statistically explained by returns to the index in which it resides, its sector and industry. So, getting the long-term asset mix right is critical to meeting the objectives of any portfolio, and far more important than security selection.
Most investment policies allow for some degree of tactical flexibility by the investment manager. In such cases, we employ an opportunistic approach to tactical allocations (within policy guidelines), initiated by our systematic expected return assessments for various asset classes.