Asset Allocation Portfolio Construction
Asset AllocationA Guide to the Fundamentals of Portfolio ConstructionWHAT IS ASSET ALLOCATION?60/40 PortfolioAs its name suggests, asset allocation is the collective percentageof investable capital ‘allocated’ to each ‘asset’ class. Theconventional ‘60/40’ stock and bond portfolio showcases atraditional asset allocation model. Namely, 60% of investablecapital is allocated to stocks while the remaining 40% ofinvestable capital is allocated to bonds (see chart).StocksBondsASSET CLASSESTraditional asset classes fall into two broad categories: equities(stocks) and non-equities (bonds and cash). Alternativeinvestments represent a non-traditional category in modernportfolios. These broad asset classes consist of multiple ‘sub’asset classes (see chart). For example, large-capitalization U.S.equities and international equities are sub asset classes withinthe broad equity asset class. U.S. Treasury notes and investmentgrade bonds are sub asset classes within the broad non-equityasset class. Managed futures and long/short strategies are subasset classes within the broad alternative asset class.THE IMPORTANCE OF ASSET ALLOCATIONAsset allocation is the most predominant component of portfolioperformance. Studies have shown that asset allocation accountsfor approximately 86% of portfolio returns. 1 In short, thepercentage of assets allocated to equities vs. non-equities is theprincipal determinant of portfolio performance over time.Brinson, Beebower, Hood. Determinants of Portfolio Performance. 1986.1Asset ClassesU.S. EquitiesInternationalEquitiesInvestment GradeBondsAlternativesCash1
ASSET ALLOCATIONRISK PREMIUMGiven that asset allocation determines a preponderance ofportfolio returns, an investor may be tempted to allocate allof his assets to the asset class with the most upside potential.Generally speaking, asset classes with the greatest upsidepotential also have the greatest downside potential. Conversely,asset classes with the least upside potential also have the leastdownside potential. This is known as risk premium. Over time,an investor should be rewarded relative to the risk he assumes.HigherReturnsEquities Return: 7.68%Standard Deviation: 15.29Bonds Return: 5.29%Standard Deviation: 3.44LowerReturnsLower RiskSource: Morningstar Direct, 12/31/1989 - 12/31/2017 Positive CorrelationHigher Risk Negative CorrelationCORRELATIONEffective asset allocation can also insulate portfolio returns fromexcess volatility. This can be achieved by allocating capital withrespect to the correlation of each asset to other assets within theportfolio. Correlation measures the degree to which assets movein the same or opposite directions. This measure ranges from 1 to -1. Assets which are positively correlated ( 1) move in thesame direction, while assets which are negatively correlated (-1)move in opposite directions. Assets which have no correlation (0)do not move in relation to each other (see charts). By allocatinga percentage of capital to negatively or non-correlated assets,portfolio returns can be insulated from market volatility. No CorrelationDIVERSIFICATIONThe performance of different asset classes varies year to year. The best performing asset class in one year can easily be the worstperforming asset class next year (see below). Past results are not indicative of future performance. The ability to consistently andreliably pick the best performing asset class each year has proven to be a nearly impossible task. A balanced, well-diversified portfoliohas proven to be one of the best ways to capture consistent returns over time. A balanced portfolio offers exposure to the upsidepotential of multiple asset classes while attempting to limit downside risk (see chart below).Equity16.7%Commodities16.2%2008Fixed Income5.2%Cash &. io7.8%-21.7%Fixed 201020112012Real EstateU.S. EquityReal EstateFixed IncomeU.S .S.PortfolioEquityEquityU.S. EquityU.S. EquityCommoditiesU.S Equity2.1%16.8%15.3%12.6%0.5%11.8%21.1%U.S. EquityCommoditiesU.S. EquityU.S. Equity28.3%16.8%1.0%16.4%BlendedBlendedCash & 20.2%11.9%0.1%11.0%18.9%Cash & CashNon-U.S.AlternativesEquity4.7%-45.5%Real EstateReal Estate-5.0%-50.2%Non-U.S.Equity11.2%Real EstateFixed Income-8.7%4.2%Fixed IncomeFixed IncomeCommodities5.9%6.5%-13.3%Cash & CashCash & -13.7%Cash & CashAlternatives0.1%BlendedBlendedCash & 13.9%7.1%0.0%7.1%Real EstateFixed Income1.6%6.0%Cash & CashCash & CashAlternativesAlternatives0.1%0.0%Fixed Income-2.0%Equity27.2%Real rtfolio-0.2%4.5%13.8%Real EstateReal EstateFixed Income-1.2%3.8%3.5%Fixed IncomeCommodities2.7%1.7%Cash & CashCash & oditiesCommodities-1.1%-9.5%-17.0%-24.7%Blended Portfolio Allocation: 45% U.S. Equity / 15% Non-U.S. Equity / 40% Fixed Income; Source: Morningstar Direct, as of 12/31/2017Investing always involves risk and you may incur a profit or loss. No investment strategy can guarantee %2016Fixed IncomeU.S. EquityU.S. Equity201519.3%40.2%5.1%2014Real EstateReal EstateU.S. Equity2013Best2007Non-U.S.2
ASSET ALLOCATIONDETERMINING PROPER ALLOCATIONSAs previously indicated, the most crucial determinant of portfolioperformance lies in the percentage of assets allocated to equitiesvs. non-equities. So how should an investor determine hisallocations to each asset class?While equities may offer the best potential for growth over anextended period of time, their returns are often more volatilethan bonds. Conversely, while non-equities may offer thebest potential for capital preservation, their returns oftenunderperform equities over extended periods (see charts below).Annual Returns: Equities vs. Fixed Income40%U.S. EquitiesFixed Income30%TIME HORIZONWhile many factors can affect an investor’s ultimate assetallocation, his individual investment time horizon will havethe most impact. An asset allocation suitable for a youngprofessional at the start of his career is not necessarily suitablefor an executive who is nearing retirement. For those whohave long investment time horizons, higher allocations toequities may provide better potential for growth and wealthaccumulation. Conversely, for those with shorter time horizons,higher allocations to non-equities may provide better potentialfor stability and wealth preservation.RISK TOLERANCEEqually important to an investor’s asset allocation is his risktolerance. Assets with greater upside potential generallycarry greater risk. While stocks generally outperform bondsover extended periods of time, they are generally much morevolatile and carry a greater risk for loss. Conversely, while bondsgenerally underperform stocks over extended periods of time,they are generally much less volatile and carry less risk for loss.20%10%0%-10%-20%-30%-40%Therefore, a suitable asset allocation must be tailored toan investor’s individual time horizon, risk tolerance, andinvestment goals.199019952000200520102015Growth of 100: Equities vs. Fixed Income 1500U.S. EquitiesINVESTMENT GOALSFixed IncomeFinally, an investor’s asset allocation must align with hisinvestment goals. If an investor wishes to grow and accumulatewealth for retirement over a long period of time, a higherallocation to stocks may be suitable. Conversely, if an investormerely wishes to preserve wealth and reduce his risk for loss, ahigher allocation to bonds may be suitable. 1200 900An investor’s time horizon, risk tolerance, and investment goalsare often synthesized in an investment policy statement. ARaymond James advisor is uniquely suited and trained to assessthe individual needs of an investor and tailor an asset allocationin order to help successfully reach his investment objectives. 600 300 0If an investor has a low tolerance for risk, a portfolio with asmaller percentage allocated towards stocks and a greaterpercentage allocated towards bonds may be more suitable.Conversely, a portfolio with a greater percentage allocatedtowards stocks and a smaller percentage allocated towardsbonds may be more suitable for an investor with a high tolerancefor risk.199019952000200520102015Source: Morningstar Direct as of 12/31/2017Investing always involves risk and you may incur a profit or loss. No investment strategy can guarantee success.3
ASSET ALLOCATIONAll content written and assembled by Taylor Krystkowiak,Investment Strategy Analyst.DISCLOSURESU.S. EQUITY / STOCKS Russell 3000 Total Return Index: Thisindex represents 3000 large U.S. companies, ranked by marketcapitalization. It represents approximately 98% of the U.S. equitymarket. This index includes the effects of reinvested dividends.NON-U.S. EQUITY MSCI ACWI Ex USA Net Return Index: The indexis a market-capitalization-weighted index maintained by MorganStanley Capital International (MSCI) and designed to provide abroad measure of stock performance throughout the world, withthe exception of U.S.-based companies. The index includes bothdeveloped and emerging markets.GLOBAL REAL ESTATE FTSE EPRA/NAREIT Global Net ReturnIndex: This index is designed to track the performance of listedreal estate companies and REITs in both developed and emergingmarkets. By making the index constituents free-float adjusted,liquidity, size and revenue screened, the series is suitable for useas the basis for investment products. Prior to 2009, this asset classwas represented by the NASDAQ Global Real Estate Index.CASH & CASH ALTERNATIVES Citigroup 3 Month U.S. Treasury-BillTotal Return Index: This index is a measurement of the movementof 3-month T-Bills. The income used to calculate the monthlyreturn is derived by subtracting the original amount invested fromthe maturity value.FIXED INCOME / BONDS Bloomberg Barclays Capital AggregateBond Total Return Index: This index represents securities that areSEC-registered, taxable, and dollar denominated. The index coversthe U.S. investment grade fixed rate bond market, with indexcomponents for government and corporate securities, mortgagepass- through securities, and asset-backed securities.COMMODITIES Bloomberg Commodity Total Return Index: Theindex tracks prices of futures contracts on physical commoditieson the commodity markets. The index is designed to minimizeconcentration in any one commodity or sector. It currently has22 commodity futures in seven sectors. No one commoditycan compose less than 2% or more than 15% of the index, andno sector can represent more than 33% of the index (as of theannual weightings of the components). The weightings for eachcommodity included in the Bloomberg Commodity Index arecalculated in accordance with rules that ensure that the relativeproportion of each of the underlying individual commoditiesreflects its global economic significance and market liquidity.Annual rebalancing and reweighting ensure that diversity ismaintained over time.ALTERNATIVES Alternative investments involve substantialrisks that may be greater than those associated with traditionalinvestments and are not suitable for all investors. They may beoffered only to clients who meet specific suitability requirements,including minimum-net-worth tests. These risks include, but arenot limited to, limited liquidity, tax considerations, incentive feestructures, potentially speculative investment strategies, anddifferent regulatory and reporting requirements.STANDARD DEVIATION Standard deviation is a measure of thedispersion of a set of data from its mean. It is calculated as thesquare root of variance by determining the variation between eachdata point relative to the mean. If the data points are further fromthe mean, there is higher deviation within the data set. In finance,standard deviation is a statistical measurement; when applied tothe annual rate of return of an investment, it sheds light on thehistorical volatility of that investment. The greater the standarddeviation of a security, the greater the variance between each priceand the mean, indicating a larger price range.ADDITIONAL DISCLOSURES Any charts and tables presentedherein are for illustrative purposes only and should not beconsidered as the sole basis for an investment decision.There can be no assurance that the future performance of anyspecific investment or investment strategy made reference tobe profitable or equal any corresponding indicated historicalperformance level(s). This information should not be construedas a recommendation. The foregoing content is subject tochange at any time without notice. Content provided herein isfor informational purposes only. There is no guarantee that thesestatements, opinions or forecasts provided herein will prove tobe correct. Past performance is not a guarantee of future results.Indices and peer groups are not available for direct investment.Any investor who attempts to mimic the performance of anindex or peer group would incur fees and expenses that wouldreduce returns. All investing involves risk. Asset allocation anddiversification does not ensure a profit or protect against a loss.Dividends are not guaranteed and a company’s future ability topay them may be limited.4
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for approximately 86% of portfolio returns.1 In short, the percentage of assets allocated to equities vs. non-equities is the principal determinant of portfolio performance over time. Asset Allocation A Guide to the Fundamentals of Portfolio Construction 1Brinson, Beebower, Hood. Determinants of Portfolio Performance. 1986. U.S. Equities .
Asset Allocation is the art of combining different asset classes into one single portfolio. For institutional wealth managers as well as for ultra high net worth individuals, the decisions to be taken in asset allocation are more important than picking single stocks or bonds. In section one, different forms of asset allocation are described.
Asset allocation is a portfolio choice among broad investment classes. According to Swensen (2005): Construction of a financial asset portfolio involves full measures of science and art. The science encompasses the application of basic investment principles to the problem of combining core asset classes in an efficient, cost effective manner.
On a monthly basis your portfolio's asset allocation will be reviewed in order to reflect the LGT Market Views. Additional risk analysis and dedicated asset allocation research is also incorporated into the portfolio's construction process by a team of investment managers. This means your portfolio will be benefitting from the
Benchmark: A benchmark is a measure to what you compare your fund's returns with to judge its performance. Return Date: The calendar date the return data is "as of." Portfolio Date: The calendar date the allocation data is "as of." Asset Allocation: Your asset allocation is how your money is divided among different asset classes and investment types, such as stocks, bonds, real
Asset Keeper Pro - Fixed Asset Cycle Asset Keeper Pro - Fixed Asset Cycle Page 5. Fixed Asset Cycle: Building your own Fixed Asset Cycle If you would prefer to add your own steps to the Fixed Asset Cycle because you are unsure of the procedure that you currently use, you can use the Add Step button. This provides a very quick method
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Practical Considerations for Factor-Based Asset Allocation . Much has been written about the shortcomings of the traditional approach to asset allocation. . use of risk parity on the asset class level as an approach to reduce the potentially
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