SMSF Investment Strategy – Asset Allocation

What is asset allocation?

Asset allocation is the process by which you decide what proportion of your portfolio is invested in each specific asset class, including equities, fixed interest, property, cash and alternative investments.  Research has shown that the asset allocation decision is the most important factor when it comes to explaining long-term performance of an investment portfolio.

For that reason, Blueprint Wealth invests significant time into this stage of the investment process.  Employing a deliberate asset allocation as part of your investment process ensures a discipline in your portfolio and prevents one of the big mistakes of investment – putting too much faith in the performance or risk characteristics of any one asset class.

Strategic Asset Allocation

The Strategic Asset Allocation (SAA) of a portfolio is designed to guide the long-term “average” allocation over a full economic cycle.  It takes into consideration both the historical and expected future correlation and performance of assets.  The SAA is designed to optimise the risk-return balance for his or her designated level of risk.  It is, therefore, a risk-aware measure and will be different depending on the risk tolerance of the individual investor.

The SAA is based on the reality that over an economic cycle, some asset classes may perform well whilst others may perform poorly.  The goal is to include assets in your portfolio which offset each other, thereby stabilising returns at the portfolio level.  A good example of that often occurs between US shares and US long-term bonds.  Their price movements are often in the opposite direction, making them potentially good bedfellows in a long-term portfolio as the risks of one can help offset the risks of the other.

An investor may choose to modify their asset allocation for a part of the investment cycle, for example.  Good practice dictates that this deviates only slightly from the strategic asset allocation (which provides the baseline and the discipline underpinning asset allocation decisions).  Changes to the asset allocation might be driven by the desire to capture value opportunities that arise in the market (for example a divergence in value between shares and bonds) or to take defensive action against previously unforseen risks (for example the European Debt Crisis).  Our approach is to only ever make moderate adjustments to the asset allocation, within +/- 10% of the SAA.  This way we avoid over-commitment and overconfidence mistakes that can otherwise easily feature in investment decisions.

At Blueprint Wealth, our investment committee meets every quarter to consider the state of the economy and the markets. We translate the qualitative views on the global economy and markets into “underweight” and “overweight” biases for each asset class. We make asset allocation decisions based on these considerations, within the limits described above.  The strength of conviction is measured from 1 to 10, and that is applied as either a positive or a negative “tilt” to the SAA.  The result is our asset allocation for the coming quarter.

Small changes in asset allocation can have a big impact on the performance of your portfolio, so asset allocation is a very important step in portfolio design.  For example, in 2011, Australian Shares fell 10.8% whereas Australian Fixed Interest rose 11.05% (Source: Yahoo Finance).  A mere 5% difference in asset allocation made over a 1% difference to the portfolio return.  Clients who didn’t exercise asset allocation at all could have experienced over a 10% difference in returns.

For more information please contact us at Blueprint Wealth.

By Greg Major (Authorised Representative & Director), Blueprint Wealth.

Blueprint Planning Pty Ltd Trading As Blueprint Wealth ABN 78 097 264 554
Authorised representative of AMP Financial Planning Pty Limited. ABN 89 051 208 327 AFS Licence No 232706