Asset allocation is the process that determines the different asset class distribution within an investor’s portfolio. This process balances the risk and return across a combination of asset classes within a portfolio. Assets can be categorised as growth or defensive. Growth assets are investments that tends to carry high levels of risk, but also offer potential for higher returns over time. Whereas, defensive assets carry lower levels of risk, and typically lower returns. Equities are an example of a growth asset, whereas fixed income and cash are examples of defensive assets.
Assetclasses perform differently in different market cycles, therefore, investorsare encouraged to employed a diversified approach in their asset allocationprocess. Combining asset classes where the performance is relativelyuncorrelated, so that when one asset class underperforms, this is offset bythe performance of another asset class.
There are three common approaches to asset allocation:
- Strategic asset allocation (SAA) is constructed on the basis of long term asset class forecasts with targets to maintain a set combination of asset classes.
- Dynamic asset allocation (DAA) is an active strategy that adjusts the allocation of assets based on medium term views.
- Tactical asset allocation (TAA) is also an active asset allocation strategy, whereby the allocation is adjusted to take advantage of short term market opportunities.
Investors should be aware that the more active asset allocation strategies typically incur active fees or higher management costs.
GivenSAA is constructed on the basis of long term asset class forecasts, thisapproach is considered appropriate for investors that won’t require access totheir portfolio for at least the next five years. The investors time horizon,risk tolerance and investment objective are taken into consideration whenselecting the appropriate SAA strategy. From an industry perspective, SAAstrategies are commonly labelled to reflect the investors risk tolerance.Labels include moderate, balanced and growth. Below are examples ofHypothetical Model Portfolio Allocations for the State Street ETF ModelPortfolios
The forecasts driving a portfolios asset allocation will evolve over time to align with the fundamental, structural an d market changes. Therefore, it’s important to continually review and monitor asset allocation forecasts to ensure they align to the risk and return objectives of the SAA strategy. The State Street ETF Model Portfolios are founded on an SAA framework. The portfolios asset allocation is reviewed and updated annually and reflect our portfolio management team, the Investment Solution Group’s (ISG), long-term capital market assumptions and qualitative insights.
Reflective of asset class forecasts, the portfolio's actual allocations will also fluctuate over time. All else being equal, assets that have performed well will consume a bigger share of that portfolio's value and assets that have done poorly will decrease from their initial asset allocation. ISG believes that strategic portfolios should be rebalanced to the annual reconstitution weights on a quarterly basis.
SAA provides investors with a longer-term investment horizon, a disciplined and diversified asset allocation regime and is therefore utilised as an asset allocation strategy for the State Street ETF Model Portfolios. It is no surprise many investors have chosen to include these strategies as part of a core satellite approach.
