The single biggest contributor to investment performance variability, by a long shot, is the mix of asset classes.
A 1991 academic study found that more than 91.5 per cent of a portfolio’s return variability is attributable to its asset allocation. In this study, individual stock selection and market timing accounted for less than 7 per cent of a diversified portfolio’s return.
Conversely, asset allocation is also the biggest detractor with regard to performance.
For example, since the global financial crisis, portfolios with a meaningful allocation to equities have outperformed portfolios with a low allocation to equities by almost 3 per cent per annum.
So how can the average investor (and adviser) determine the optimal asset mix for their superannuation and investment portfolio on an ongoing basis while ensuring adequate diversification, which is a vital risk management tool?
In short, they can’t.
Small number of asset classes
For starters, retail investors only have direct access to a small number of asset classes, namely domestic shares, term deposits and, potentially, property. Therefore, they’re missing out on the vast majority of investment opportunities.
Access aside, the average investor doesn’t have the experience, skill or the sophisticated software and modelling tools required to accurately value asset classes, determine the appropriate percentage to hold, continuously monitor portfolios, make dynamic decisions and ensure those decisions are executed efficiently.
It’s a key reason why a growing number of financial advisers are following the lead of large institutional investors, like superannuation and sovereign funds, and appointing an asset consultant to help them with their asset allocation and risk management strategy.
Not only can an asset consultant set a portfolio’s optimal strategic asset allocation and help with manager selection, they’re able to make dynamic and opportunistic portfolio changes based on market conditions, execute those decisions and monitor a portfolio’s composition, performance and risk on an ongoing basis.
Access all areas
The simplest way for retail investors to access the expertise of a professional asset consultant is via a managed account program as part of a broader strategic advice plan.
First of all, an adviser will provide strategic advice based on the client’s financial position and needs, their short, medium and long-term goals and objectives, and their ability and capacity to take on risk.
An adviser will then work with the managed account operator, and typically an asset consultant or research house, to set an investment framework and parameters around how the client’s money will be invested. This framework must be agreed to by the client and reviewed every 12 months to ensure it continues to be relevant to the client’s needs.
An investment program typically sets out a portfolio’s general holdings, strategic asset allocation ranges and maximum single stock exposure.
Under a managed account structure, investment management and portfolio implementation is often outsourced to a third party asset consultant, research house or fund manager.
Additional layer of expertise
This additional layer of expertise ensures that once an appropriate strategy is in place, a professional manager is responsible for exercising trades, executing tactical asset allocation decisions and rebalancing portfolios in a timely and efficient manner. This has the potential to deliver valuable additional returns to clients over time.
Perhaps the biggest benefit is improved client outcomes because portfolios are consistently and professionally managed in line with a clear investment framework agreed to by the client.
Clients don’t have the stress often associated with making regular portfolio decisions.
They have the confidence and peace of mind of knowing that their wealth is being managed in line with their needs and objectives.
Another major benefit is that a managed account program, which involves an asset consultant, typically allows investors to hold a wide variety of listed and unlisted assets including Australian and international shares, managed funds, ETFs, hedge funds, listed income securities, bonds, term deposits and cash.