Hi, I'm Andreas Zingg. Hi, I'm Mohneet Dhir and in this video, we'll be looking at benefits of strategic asset allocation within multi-asset investing. So the first obvious question is what is the strategic approach to asset allocation? I think first thing’s first, strategic asset allocation is essential for investors who are looking at a long term investment horizon, have a specific goal in mind.

But before we sort of dive into that, I think it's important to remember that often investing doesn't need to be overly complicated and that is certainly the case when investors think about strategic asset allocation. Now, strategic asset allocation is effectively exposing your portfolio to two particular asset classes, that’s equities and bonds, setting an allocation for them, and in-line with your longer term objective, along with regular rebalancing, to make sure that you don't drift away from those set asset allocations.

The other point to remember is that strategic asset allocation essentially allows you to spread your risk, if you will, provides you diversification, so when you invest in global equities or global bonds, through strategic asset allocation, you’re effectively investing in the broad market, which obviously diversifies your risk a lot, which is great for investors.

There are two primary approaches to strategic asset allocation. The first one is what we call a steady asset allocation approach, where you set the allocation within your portfolio, say 60% equities, 40% bonds, and you maintain that over the long term, along with regular rebalancing to make sure your portfolios don't drift as markets move. The second approach is a time varying approach or dynamic asset allocation approach, if you will, which looks to optimise returns and objective of the portfolio and based on changes to medium term forecasts and as a result, asset allocation changes on the back of that. You mentioned rebalancing, there is a separate video on rebalancing. So you also mentioned these two approaches, steady and dynamic. Important to note is the dynamic asset allocation approaches at Vanguard are based on medium term, not short term forecasts. So when advisors or clients have the choice between the two, between steady and dynamic, what are the considerations they should make? Yeah, I think between the two, the key thing is the type of risk that investors are taking. So for the steady asset allocation, what can often happen is because you're not changing your underlying asset allocation, the markets are still moving over the short term and over the medium term. So for example, if there's a big shift upwards or downwards in interest rate across global markets, that can mean that markets will become more volatile and investors may see under or outperformance over the short term and the medium term. That can really test an investor’s discipline, especially if you look at a year like 2022, for example, where, you know, markets were extremely volatile and that's something that investors will have to think about when they think about steady asset allocation. Can they go through the longer term with that discipline? The second part for the time varying asset allocation, or dynamic, if you will, the risk that investors are taking there essentially is to do with forecasting. And also there is a certain risk of underperformance in some ways because you are changing your asset allocation based on medium term risk forecasts, which can obviously change as well.

However, that's part and parcel of investing to a certain extent. So in other words, forecasts can be wrong. Yeah, absolutely they can be. And I think that's one thing for investors to obviously keep in mind, just be aware of the risks that they're taking when they're choosing between a steady asset allocation approach or a dynamic asset allocation approach. Within this as well it's important for investors to remember so, for example, if they're taking the steady asset allocation approach, they can still have different options depending on their risk appetite. So for example, if an investor chooses steady asset allocation is the way to go for them and they have a slightly higher risk tolerance, or risk appetite, if you will, they can have an exposure to around 80% to equities.

However, if they have a lower risk appetite, they could lower their equity exposure, find a portfolio which has exposure to equities closer to 60%, for example. Now for investors with a specific investment objective, whether that's an annualised return or whether there's a specific risk target that they're aiming for, that's where a dynamic asset allocation approach is very relevant for those investors.

This is where the advisor comes in, needs to figure out with the client actually what's the right multi-asset solution, be it a steady or a time varying approach. So to the next question, how do strategic multi-asset solutions deliver value? And I can start with this one. I think the foundational idea of multi-asset solutions is a combination, as you mentioned, equities and bonds, and that's because there is typically a negative correlation between stocks and bonds.

So that means on average, when the performance of stocks is positive, the performance of bonds is negative and the other way round. There have been, and 2022 has been such an example, there are periods when the correlation turns positive. However, these periods have been limited in time in the past and typically went then back to a positive correlation.

And what's even more than the correlation, which is just the correlation between average returns, is that when the stocks really struggle, that the bonds actually hold the portfolio, act as ballast to the portfolio. And I think what's also important is the role of stocks and bonds in a multi-asset portfolio that investors understand that. So the return driver should be the equity allocation, whereas like the bond allocation brings ballast to the portfolio plus actually the coupons, the regular distribution of bonds.

Yeah, I know, absolutely. And I think just to add to that, the way that investors can think about how strategic asset allocation or steady asset allocation in particular delivers value is to understand the flipside or the opposite of it. So if you look at tactical asset allocation, which essentially means that you're making changes to your portfolio based on short term market movements, short term market volatility, it can be really difficult, it might be well intentioned, but it can be really difficult to get it right consistently again and again if you're making changes based on short term forecasts. And that is also introducing a certain level of risk into the investor portfolios, so if an investor went in, you know, invested in a portfolio because it has 60% equities, because that's their sort of risk appetite, a tactical allocation may mean that you've actually gone from 60 to 65 or even 70%, and that is essentially increasing your overall risk in the portfolio, which is something that investors should be very mindful about.

Thank you. I hope this video has been informative. Mohneet and myself, we have produced more videos on portfolio construction and multi-asset solutions, so if you're interested, please check them out as well. With that, thank you and goodbye.