What is asset allocation and why does it matter?

What is Asset Allocation?

Asset allocation describes how the funds in a portfolio are distributed among different asset classes such as equities, bonds, real estate, commodities, private equity and private debt. Those involve different levels of risk and return and play very different roles within a diversified portfolio.

The weighting of each asset must meet the financial objectives of the investor. It aims to maximize the performance of the portfolio while preserving its solvency and respecting the risk tolerance of the investor.

Asset Allocation Strategies

The decision to allocate assets within a portfolio is the very first and also a critical step in the portfolio management process and will very likely evolve during lifetime.

Cash and liquid assets generally contribute to security and flexibility, while fixed income securities aim to provide stability and regular income. Equities offer the growth potential necessary to meet return objectives.

Several approaches to asset allocation exist:

  • It can be said to be “passive” and based on a target weighting of each asset in the portfolio that does not vary over time. Periodic rebalancing ensures not to stray from it. The objective of this strategy is to create an asset allocation offering an optimal balance between risk and expected return over a long-term horizon.
  • In contrast, “active” management offers the possibility of dynamically adjusting the asset allocation in the portfolio. Each asset has an initial target allocation, but the manager can deviate from it within an authorized allocation range, generally between 20% and 80%. This greater management latitude offers more flexibility and the possibility of taking advantage of market opportunities arising in the short term. This approach aims to increase the expected return of the portfolio while mitigating risk by strategically adjusting the asset allocation.

The selection of the type of allocation model depends on each investor according to the time horizon of investment and his risk appetite, but the goal remains constant: attempt to maximize return while minimizing risk. It is a risk-return tradeoff to create the optimal portfolio for the investor.

Standard Portfolios by Asset Allocation Strategies

As explained previously, the asset allocation that works best for an investor at any given point in his life will depend largely on investment’s time horizon and his ability to tolerate risk.

The ideal asset allocation is the mix of investments, from most aggressive to safest, that will earn the total return over time that you need respecting your tolerance to volatility and tolerance for risk.
Source: David A. Hammer. Dynamic Asset Allocation: Strategies for the Stock, Bond and Money Markets, Roger C. Gibson. Asset Allocation: Balancing Financial Risk.

General Considerations

An indispensable element to keep in mind when defining the asset allocation of a portfolio is the importance of diversification. Including asset categories with investment returns that move up and down under different market conditions helps the investor to prevent significant losses. But diversification intervenes at several levels: diversity of financial institutions, type of financial instruments, investment sectors, countries of exposure, currencies, etc. It will be all the more efficient as all of these complex parameters are strategically coordinated.

In times of market volatility, an asset allocation strategy is even more crucial. Indeed, it allows flexible management of the portfolio that can adapt to fast-changing economic conditions.

Periodic rebalancing of portfolios ensures to always fit to investor’s changing needs for capital management.

K&B Family Office can help you find the best asset allocation according to your investment profile

While asset allocation is central to a long-term wealth management strategy, it requires a total understanding of the various investment vehicles available in the market. It also necessitates a strict discipline to stick to the investment strategy, especially in extreme market situations, and an extensive capacity to control emotions. For all those reasons, many investors entrust the management of their portfolio to a professional advisor.

Thanks to a personalized analysis of your goals and risk profile, the K&B Family Office team of experts can help you gain a clearer picture of the optimal investment strategy and provide you actively managed portfolio solutions to boost expected returns. The easiest way to start is with a 30 minutes meeting with one of our advisors.

 

Louise Laborde
Senior Portfolio Analyst

To learn more, contact us at:
info@kb-familyoffice.com

 

September, 2020

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