Asset allocation has become a much-discussed subject in the wake of the financial crisis. For some advisors and market observers, the old strategic asset allocation approach from "Modern Portfolio Theory" is dead. Other experts will tell you that strategic asset allocation will come back and have the last laugh when all is said and done. I'd venture that there was another way to broach the subject. Call it "insightful asset allocation."
This column will explore asset allocation on an ongoing basis from a simple yet relatively untried premise: Asset allocation is indeed the most critical determinant of an investment program's success, and while history doesn't necessarily repeat itself, it can help us develop some gauge of future market behavior. What is called for in today's changed market landscape, therefore, is a view of asset allocation that follows this line of thought. The objective for this column will be to offer a variety of perspectives on the many various components and possible approaches that go into a more insightful asset allocation – from macro calls to manager selection to actual portfolio construction.
Our framework is as follows:
- The global capital markets are largely efficient in the long run
- There is a tradeoff between risk and return
- Investors aren't compensated for risk that can be easily diversified away
- Active investment managers can and do add value
- Combining diversified asset allocation portfolios with intelligent manager selection is where insight begins.
In other words, asset allocation from this vantage point is about helping advisors construct portfolios, with optimal potential, across a spectrum of market outcomes tailored to individual investor needs.
Insightful asset allocation involves more than creating the "right" blend of stocks, bonds and cash based on a client's risk tolerance; it requires insight into a client's tax situation, retirement income needs and time horizon, as well as enough dynamism to account for changing market cycles and levels of volatility. A number of solutions and tools are emerging on this front to help advisors manage the task, from specialized funds and separate account managers to tools and services on investment platforms. We'll use this column to delve more into the various approaches and products at our disposal.