Asset allocation is a term used in the investment industry, but what actually is it? Why is it important? How do Warwick clients benefit from it through our value proposition?
Asset allocation is the process whereby the funds available for investment are allocated between the major categories or asset classes available to the investor. These asset classes can be broadly categorised as stocks, property, fixed income (bonds and cash instruments) and offshore assets. By going through this process, the investor ends up with an investment portfolio divided between the abovementioned asset classes and this would the resultant asset allocation of the portfolio.
There are a number of reasons why asset allocation is key to the management of an investment portfolio. The most important is risk mitigation. Asset allocation helps reduce risk/volatility through diversification. As the saying goes, “the only free lunch in investing is diversification”. All the asset classes have different risk-return profiles and they also perform differently from each other under different economic conditions. By diversifying a portfolio between asset classes, you mitigate the risk of being only invested in an underperforming asset class given, particularly the current economic environment. The ideal asset allocation for a given investor is based on the investor’s own goals, time horizon and risk tolerance. Importantly, asset allocation is an ongoing process which needs to be reviewed regularly. Countless studies have shown that investors’ asset allocation is the primary driver of portfolio returns.
Our clients benefit from a proactive asset allocation approach through our bespoke value proposition. This value proposition includes regular contact, face-to-face reviews and investing via a Category II discretionary mandate. This mandate allows our appointed asset managers the leeway to adjust the various investment strategies, within defined risk parameters, at the appropriate time.
As an example of how this proactive approach works, let’s look at a scenario where stock markets have fallen. Looking at the investment portfolio after a contraction would then show that stocks are underweight and fixed income may be now overweight given the risk profile of the client. By using the discretionary mandate to adjust the asset allocation after the contraction, the portfolio is then repositioned back to model weight. As the stock market recovers the investor has more stocks in their portfolio due to the rebalancing and thereby can enjoy superior returns. Once again, a rebalancing will take place to ensure that if and when markets fall, the investor is not overweight stocks based on the appropriate risk profile. This ensures that optimal outcomes for the investor are achieved.