Asset Allocation 101


As we head towards fiscal year-end many investors will be finalising their superannuation contributions, reviewing their investment portfolio (both  within their superannuation structure and external investments), adjusting some investments post the May Budget, realising some profits or losses and broadly adjusting their core asset allocation for the year ahead.

Constructing the appropriate asset allocation will vary for every investor and circumstance.Your asset allocation is your core driver of investment performance through your life cycle that needs to stand the time of many different economic cycles. It is no surprise that the appropriate asset allocation will differ for most investors, depending on the return expectations, risk tolerance (can you sleep at night?), time horizon and the stage of your life cycle (for an individual).

Most investors should be diversified across all asset classes, and within each asset class, to help lower the volatility of your portfolio returns.  The clear goal of course is to have exposure to asset classes that are negatively correlated through a cycle. Protecting your capital (wealth) and limiting the downside are important.

The 1991-92 Australian recession (our last recession), the Asian financial crisis (1997/98), the technology bubble meltdown of 2000-2001, the unforgiving global financial crisis (2008) and the many different European credit crunch episodes (a trilogy of Greek dramas from 2009 through to 2016, to be possibly followed by an Italian drama later this year) are some clear examples that diversified portfolios significantly lower the volatility of your portfolio.

The art of portfolio diversificationis that it effectively reduces the risks and helps increase your wealth systematically over time. Building wealth slowly over your lifecycle is the best approach. Unfortunately, many people do not have the patience.

The starting point, in fact your building block for portfolio construction, is one’sStrategic Asset Allocation(SAA). So what is your appropriate weighting to the key asset classes? This will typically consist of the following: Cash, Fixed Income, Equities (domestic and global), A-REITs (listed property securities), direct property and Alternatives (i.e. private equity, commodity themes, and hedge funds).

Your SAA weightings will reflect your “long term” return expectations (you need consistent income to live on in retirement), the level of volatility you can tolerate to be able to sleep at night (negatively correlated asset classes lower volatility of a total portfolio) and what stage of your life cycle you are at.  Clearly, for an individual your SAA benchmark weightings will differ if you are 25 years of age versus 50 years of age.  You need more defensive and reliable income exposures the closer you get to pension phase. The tax structure within superannuation is also a clear driver.

There are other elements to asset allocation such as “tactical” sector tilts, which imply going “overweight” or “underweight” the various asset classes versus your bespoke SAA weighting. This will depend on who manages your portfolio and for many investors this is outsourced.

A quick look at weightings across the asset classes for a sample moderate – balanced Australian investor profile would be: 5% Cash (must always be liquid and accessible); 30% Bonds (this includes sovereign – government bonds, high quality corporate bonds, some high yield securities); 50% Equities (both domestic and global equities with a focus on low cost ETFs for large cap exposure and more active strategies for small cap); 5.0% Real Estate and 10.0% Alternatives (which includes hedge funds, pre IPO private equity, precious metals and volatility themes).

In summary, as we head into 30 June fiscal year-end, we have aimed to remind us the basic concepts and building blocks of portfolio diversification.  It is quite clear that diversification across all the asset classes, and importantly within, are such key concepts that all investors need to be cognisant of in their wealth accumulation.  Everyone needs to understand their own bespoke weighting. Of note, costs need to be considered for all investors (blending both passive and active strategies tend to work for many), but there is an optimal portfolio allocation that will meet your return expectations and take into account the level of volatility that is appropriate for your needs over time. It is all about meeting ones expectations.





George Boubouras

CIO  |  Atlas Capital
Director  | Salter Brothers Asset Management (SBAM)