Asset Allocation Principles

Asset allocation is the process of developing a diversified portfolio by effectively distributing investable resources among multiple asset classes seeking to maximize hypothetical returns and minimize potential risk.

Numerous independent studies have determined that more than 90% of a portfolio′s relative performance can be attributed to asset allocation.

Asset Allocation Process

There are four steps to the asset allocation process as follows:
Asset Allocation Pie Chart
Source: Brinson, Singer and Beebower, "Determinants of Portfolio Performance", Financial Analysts Journal, June 1991
Asset Allocation Steps
 

Selecting Asset Classes & Determining Portfolio Mix

Establishing your strategic asset allocation is a long-term approach with a time horizon well beyond five years. The process assumes multiple market cycles and is dependent upon each investor′s individual goals, needs and risk tolerance.

The foundation for selecting which asset classes to consider for portfolio construction begins with a multivariate analysis on expected returns, volatility and covariance:

  • Expected returns are derived from historical performance or forecasted taking into account current economic, fundamental and market conditions
  • Volatility is determined using standard deviation* as a reasonable measure of the risk of an asset
  • Covariance is formulated as a measure of the degree to which returns on two assets move in tandem

Tactical asset allocation is a process whereby calculated and measured adjustments are made to the long-term strategic asset allocation. The goal is to take advantage of market opportunities or anomalies available over a shorter time period. This may include over/under weighting certain asset classes or implementing a strategy based on a particular investment theme.

View the importance of diversification in a global economy


 

The Efficient Frontier

Portfolios constructed on the basis of a sound asset allocation framework are considered to be "efficient" portfolios. These "optimized" portfolios are less volatile and should not fluctuate as widely as portfolios that do not consist of an optimal blend of risk and return.

Efficient Frontier Graph Presented graphically, the efficient frontier represents a hypothetical curve depicting a series of optimal risk-return relationships (portfolios) based on return, risk and correlation data. To be deemed efficient, your portfolio would offer the maximum expected return for your stated level of risk. Or, equivalently, your portfolio would provide the minimum level of risk for the return you expect.

*The "efficient frontier" represents a theoretical boundary for optimized investment choices. It is not a guarantee or measure of the performance of any specific investments or portfolios.

*Standard deviation: the statistical measure of the dispersion of a set of data from its mean.

Please view our Benefits of Managed Futures section to learn more about this dynamic asset class.