The case for strategic asset allocation
11 November 2016 | Portfolio construction
Commentary by Brian Wimmer, a senior investment strategist with Vanguard Investment Strategy Group in London.
We talk a lot about the importance of strategic asset allocation. There's a good reason for that. Research as far back as the mid-1980s tells us that, over time, it is the most influential factor on a portfolio's return variability.
But, as we know, a lot has changed since the '80s. At Vanguard, we wanted to find out if the findings still held true, and if they held true in different markets. If they do, this makes working with clients to figure out their appropriate strategic asset allocation one of the most important tasks for an adviser.
We analysed over two and a half thousand balanced mutual funds in the United States, United Kingdom, Canada, Australia and Japan over a fifteen-year period. We found that in the UK, having studied 743 balanced funds, 80.5% of a fund's actual return variation was explained by the fund's strategic asset allocation. As you can see from the chart below, the percentages are high in other developed markets as well.
So while some things have moved on since the 1980s, some things have remained the same. The analysis confirmed the conclusions from previous research and academic studies that strategic asset allocation determines a large proportion of a fund's return variability. And this reinforces the asset allocation decision as central to the investment process.
Of course, asset allocation differs for each and every client, all of whom have different circumstances, different goals and different risk appetites. Our tools can help you as you discuss risk appetite and return expectations with your clients. And of course, we also offer our LifeStrategy range of funds with regularly rebalanced strategic asset allocations to suit different risk tolerances and client preferences.
Role of asset allocation policy in return variation of balanced funds
Selected periods, January 1990–September 2015
Notes: For each fund in our sample, a calculated adjusted R2 represented the percentage of actual-return variation explained by policy-return variation. Percentages shown in the figure – 91.1% for the United States, 86.0% for Canada, 80.5% for the United Kingdom, 89.1% for Australia, and 87.9% for Japan – represent the median observation from the distribution of percentage of return variation explained by asset allocation for balanced funds. For the period January 1990–September 2015, the sample included: for the United States, 709 balanced funds; for Canada, 303; for the United Kingdom, 743; for Australia, 580; and for Japan, 406. Calculations were based on monthly net returns, and policy allocations were derived from a fund's actual performance compared with a benchmark using returns-based style analysis (as developed by William F. Sharpe) on a 36-month rolling basis. Funds were selected from Morningstar's Multi-Sector Balanced category. Only funds with at least 48 months of return history were considered in the analysis. The policy portfolio was assumed to have a US expense ratio of 1.5 basis points per month (18 bps annually, or 0.18%) and a non-US expense ratio of 2.0 bps per month (24 bps annually, or 0.24%). Sources: Vanguard calculations, using data from Morningstar, Inc.
This article is directed at professional investors and should not be distributed to, or relied upon by retail investors. It is designed for use by, and is directed only at persons resident in the UK.
This article was produced by Vanguard Asset Management, Limited. It is for educational purposes only and is not a recommendation or solicitation to buy or sell investments.
The value of investments, and the income from them, may fall or rise and investors may get back less than they invested. Past performance is not a reliable indicator of future results.
The opinions expressed in this article are those of the individual author and may not be representative of Vanguard Asset Management, Limited
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