Building a solid foundation
Tara GillespieHead of Global AssetsFind me on LinkedIn
At Redington, we believe that starting with the end in mind is crucial to successful outcomes. It's all too easy to get caught up in the daily news cycle and market fluctuations, but if you're not focused on your long-term goals, you'll struggle to achieve them.
One of the most important factors in achieving those goals is strategic asset allocation (‘SAA’).
What is SAA?SAA means getting the optimal mix of asset classes for your portfolio based on your investment objectives, risk tolerance and time horizon.
Research has shown that SAA accounts for more than 90% of portfolio returns, with the remainder being made up by security selection and tactical asset allocation. This means that getting your SAA right is critical to long-term success.
Think of your SAA as the foundation of your investment portfolio. Just as a solid foundation is essential for building a sturdy house, SAA provides a stable structure that helps your portfolio weather the ups and downs of the market so you can achieve your long-term goals.
The numerical impact of a good SAALet's say you want to grow the real value of your assets over 20 years. You consider two portfolios:
The probability of meeting your objective for these two portfolios is around 66% and 50%, respectively.
If these portfolios were implemented through highly-skilled active fund managers who consistently delivered alpha, these probabilities would improve to around 71% and 56%, respectively. The point being, even with skilled active management, you can't turn Portfolio 2 into the optimum portfolio for the set objectives.
That isn’t to say that tactical asset allocation and active management aren’t additive. In fact, the analysis we show below demonstrates that, if done well, these factors can materially enhance investor outcomes. However, setting the right SAA for the objectives in hand has to come first.
Standing still or moving backwards?Referring back to the theme of this edition, though, is standing still in this way a step backwards or a step towards achieving client goals?
Recent market volatility has prompted several articles arguing for the former, criticising the merit of SAA and the long-favoured 60/40 portfolio. In an earlier article written by our CIO, Pete Drewienkiewicz, we explored whether 60/40 remains a sensible strategy. We concluded that it does, but that perhaps the 40 part needed a refresh, with a small allocation to assets designed to access return sources that aren’t reliant on rising equity or bond prices.
In a similar vein, your SAA shouldn’t be set and forgotten about. Although knee-jerk reactions to market movements should be avoided, regular reviews of the SAA by investment committees are essential to ensure it remains fit for purpose in achieving long-term goals.
The furnishings to your solid foundation Starting with the end in mind and focusing your attention and governance budget on building a portfolio for your long-term goals brings about discipline and helps to ensure that the time, effort and fees spent on selecting and implementing best-in-class managers isn't in vain.
Only once you've established your SAA should you begin to fine-tune your portfolio – adding the furnishings to your house’s sturdy foundation, if you will.