The Role of Asset Allocation in our Portfolio Construction

May 24, 2010 4:46 AM ET
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Contributor Since 2010

Long Term Investment Management represent the thoughts of Alessandro Sajwani, a Senior Investment Advisor for a large European Bank. This site selects a sample of articles from the Long Term Investment Management blog. I was originally trained in Physics, where I went on to research the optical properties of quantum dots. After reading Benjamin Graham´s “THE INTELLIGENT INVESTOR”, I was inspired to pursue the capital markets. .

Dear Reader,

We live in volatile times, you don´t need me to tell you that.

However, this won´t change our approach to investing.
Today it is important we plant the seeds for growth over the next business cycle.

We have been strong proponents of the following asset allocation since bonds started to get a little optimistically valued (since end 2009):-

Cash                                     30%
Bonds                                   30%
Equities                                 30%
Structured products              07%   (selling volatility)
Alternatives                           03%

We use asset allocation as a quick means to describe to our clients:-

1. Which asset classes we feel will perform best over the next 3/5 years
2. How macro economic factors influence our allocation of capital

However, asset allocation can be used by the lazy investor to hide the dirty job of security selection.

We strongly feel security selection should guide asset allocation rather than vice versa. When we can´t find the common stock of good companies at good prices, as a natural consequence our equity allocation will drop. The same is true for all other asset classes.

Recently, the big news on everyone’s lips is the precipitous drop in the EUR/USD exchange rate. We are big holders of USD assets, not because we predicted this “macro” event occurring, but because the prices of USD assets were telling us to come. We obeyed its silent orders in early 2009.

Today, much to the disbelief of others, as was the case when we were buying USD assets, we are starting to increase our equity allocation to European companies which are starting to become attractively priced. Most likely we are starting to buy early when judged on when the equity markets “bottom”. But our game is not to buy at the bottom, our game is to buy good companies at good prices. If we do this consistently, we are likely to make above average equity returns over the entire business cycle.

I would like to finish by assisting the lazy asset allocator – or the individual that does not have time to dedicate great parts of their day to security selection and neither wishes to pay an individual like myself to manage their investment portfolio.

If we use the above asset allocation as a starting point in today’s market environment,
for every 10% drop in equities, you should add another 5% of this asset class in your portfolio. The inverse should also be true.

A 40% drop in equities should therefore increase your allocation to this asset class to 50% of the investment portfolio. Should it drop another 10% from there, I would add another 10% to have a 60% allocation to equities. This approach can be applicable to other asset classes, but with triggers to action slightly modified.

As always, we invite you to feel free to ask questions.

Yours sincerely,

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