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A sound Strategic Asset Allocation (SAA) is the foundation of successful investing and should always be the fallback position of a portfolio irrespective of the prevailing market conditions, not cash. In that sense, it must help the investor to calmly stay invested in the short term, even during market downturns. Accordingly, diversification is crucial. As I like to put it, one gets rich by concentrating investments, but one stays rich by diversifying them, and this applies both to individual asset classes and to asset allocation as a whole. Lastly, the optimal degree of diversification depends on the proportion of bankable assets to total wealth, which varies considerably from person to person.

Strategic vs tactical asset allocation: How tactical should you be?

The difference between strategic and tactical asset allocation decisions can vary from manager to manager, and, frankly, the line is sometimes blurred. The fundamental question is whether we can add value by applying a tactical overlay to our strategic asset allocation. We diligently monitor the performance of our implemented tactical asset allocation against benchmarks, including the SAA.

Many years of experience have shown me that the domestic 50% bonds/50% equities asset mix is not so easy to beat in most reference currencies and still represents a good starting point, especially after the normalisation of interest rates in 2022. Similarly, it is difficult to outperform a well-constructed SAA with tactical calls, particularly on a repeated basis. We therefore recommend investing along the SAA initially and using tactical positions sparingly, as long as markets are in a structural uptrend.

How we tackle specific asset classes 

Fixed Income

In light of the normalisation of the cost of capital in the system that started at the beginning of 2022, attractive yields are now available again without excessive risk-taking in the fixed income space. As such, bonds remain an important part of any balanced portfolio, not only from a diversification perspective but also as an additional source of return. While the fixed income asset class has many attractive features to add to a portfolio, it also has its peculiarities that need to be considered.

In general, we diversify between government bonds, investment grade corporate bonds, high-yield corporate bonds, and bonds issued by emerging market countries. In addition to these bond categories, other debt instruments, such as inflation-linked bonds or catastrophe bonds, may also be considered. Strategically, we focus our fixed income allocations on the portfolio’s/client’s reference currency. The addition of nominal debt denominated in other currencies is generally avoided, as the addition of currency risk adds little performance and a lot of volatility. This is, of course, particularly true for investors whose reference currency has a decent track record as a store of value. Investors living in countries with a history of high inflation and a chronic devaluation of paper money tend to think in US dollars or in another ‘strong’ currency.

Another important point I would like to make is that investments into the credit segment of the bond universe should always be implemented through active funds that are well diversified over a large number of issuers. Pure passive indexing is not advisable in this space, as active selection by excluding companies with risky business models and weak balance sheets is crucial. Furthermore, direct investing should only be attempted in very large portfolios managed by specialists able to provide the required diversification.

Equities

The first line of defence against capital erosion is to invest in productive real assets, i.e., equities. Strategically, such investments should be concentrated in markets that have a track record of creating long-term shareholder value. More specifically, for the equity portion of a multi-asset portfolio, we start by allocating capital to large-cap global equities with a quality bias. The quality bias tends to outperform over the long term and, above all, requires fewer transactions than, for example, a value or small-cap approach. Furthermore, the world’s large-cap companies are the largest for a reason. These are companies that, in most cases, benefit from substantial comparative advantages and the associated superior returns on invested capital.

This core allocation to global equities is then usually complemented by an allocation to equities in the domestic market of the portfolio’s reference currency. The relative weight of global versus domestic equities will vary according to the extent of the investor’s preference for the domestic currency. Finally, we provide a little more diversification to our SAA by adding selected emerging market and listed real estate exposures.

What does this mean for investors?

By following a disciplined framework, understanding the unique characteristics of different asset classes, and making informed tactical adjustments, investors can navigate market uncertainties and build resilient portfolios. The key principles of avoiding mistakes, maintaining a long-term perspective, and leveraging the expertise of a wealth manager are crucial for achieving sustainable investment success.