Commentary
 
Asset allocation back in vogue

9 June 2010


US financial icon John Bogle of the Vanguard Group of Index Funds recently came out in favour of stocks. While his own portfolio is heavily skewed towards bonds he admits that’s more a function of his age than his outlook for returns. For the record he forecasts an annualised average gain of 7% for stocks and 4.5% for bonds over the next 10 years. His advice to investors - stick to an asset allocation plan and stop worrying about volatility in financial markets. Easier said than done perhaps given the bruising stocks have taken in recent months but Bogle is not alone in his view that stocks will outperform. 

US fund manager Chris Davis, manager of the Davis New York Venture Fund (US$34B under management) & the Selected American Shares Mutual Fund (US$7.5B under management) has also made bleak forecasts for bond-fund investors. Davis claims bonds are now the biggest bubble in the world because assets have been pouring into bond funds at record pace. Both men reinforce the view that asset allocation, not tactical asset allocation (market timing) or security selection is the main determinant portfolio returns. That hasn’t been the case for a long time.



Asset allocation is about diversifying across different asset classes based on the notion that different assets reduce portfolio risk for a given level of return. As an investment  strategy however it went out of fashion in the for much of the past 20 years as returns from shares, bonds and most other asset classes were uniformly high reflecting falls in inflation during that period. The conclusion was therefore that asset allocation added little to overall returns. Now thanks to the GFC, gyrations in markets and the return of more pronounced economic cycles its being taken seriously. 

Today the investment landscape has changed. Take our own equity market for example. Returns are now much more dependent on commodities than merely the strength of the US. With such a high dependence on commodities local investors might therefore consider adding assets with an inverse correlation to commodities. Defensive assets – US Treasuries, Tech stocks, other safe haven assets such as gold might today be considered where previously they may not. Another reason to embrace asset allocation is there are simply more asset classes to chose from. Emerging market shares, Managed FX Funds, Infrastructure and Alternative asset classes all make adding different assets a real possibility. 

Determining your mix of assets depends on a range of factors not the least being your risk appetite and stage of life. Choosing the percentage you allocate to equities versus defensive assets – cash, bonds (term deposits) also will be influenced by your track record as an investor and your own balance sheet (net worth). Take Bogle as an example, a conservative investor. He believes his current asset allocation is appropriate for the tough times he sees ahead: “I would emphasise an asset allocation that begins with this crude rule of thumb of having your bond position equal to something relating to your age.” He means if you’re 60, you should consider putting 60% of your portfolio in bonds. Now in his 80s, Bogle’s portfolio follows that rule. 

Bogle’s theory is based on looking at long-term total returns, instead of day-to-day market fluctuations. With a 4.5% bond return over the next decade, Bogle points out that a patient investor who captures that gain will be up 60% over the decade, while the stock return of 7% is enough to roughly double your money over a decade. 

Elizabeth Tilley - Finance News Network 
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