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The allocation conundrum

Wednesday, March 19, 2014
Managing Your Money

Many of you who have invested in property over the years are well aware of the mantra, “location, location, location.” Loosely put, the prime consideration in property valuation is the location. Let me use the opportunity to introduce a new mantra. “allocation, allocation, allocation.” In my last piece, we noted that the allocation of an investment portfolio was considered to be the primary contributor to valuation, some argue over 90 per cent. This would be a good starting point for a discussion on allocation. 


What are the primary asset classes? Also, what portion of my portfolio should be in the different asset classes? We have equities, fixed income instruments (e.g. bonds), money market funds and alternative investments (such as commodities). Over time we will take a look at all of the different components. However, today we will focus on equities. Let me first introduce a sample asset allocation for a risk-averse or conservative investor and the associated returns involved.



Conservative/Risk-Averse Investor 
In this sample portfolio, the primary investment objective is preservation of capital and generation of income, with limited focus on capital appreciation. The conservative investor essentially chooses lower risk that may gain small profits but not be subject to great losses. This type of investor is not willing to take extensive speculative positions with his/her money and prefers to avoid heavy allocation in riskier investments like equities.


The representative portfolio suggests overall investment in equities being 25 per cent of the overall portfolio. Note that the local/regional equity allocation is some 14 per cent of the overall portfolio while the international equity component is 11 per cent.  per cent and the average return for international equities is 15.85 per cent. 



For the conservative investor with the suggested asset allocation above, the average annual return for the combined equities portion was 11.18 per cent. This makes it an important addition to any portfolio including that of the conservative investor. 



It should be noted that you will not be able to achieve immediately your desired portfolio weightings. Portfolio construction is a work in progress, especially for the aspirational investor. No matter how small or large your portfolio, discipline is probably the most important ingredient in working towards your investment targets.



As part of that work in progress, investors should consider moving from product to portfolio. What this means is that, as an investor—especially the aspirational investor—you would build upon a suite of products usually from most attractive to least attractive. 


Over time you would prune this suite of products into a portfolio with the right balance and mix to address several factors, including diversification. This will allow the investor to over time develop his/her target portfolio allocation. 



No matter how you cut the cake it would be difficult to build a balanced, diversified portfolio without equities. The price movements upwards will enhance the value of your portfolio. The corollary is true for downward movement. However, by limiting the extent of equity holdings, in this case to 25 per cent, you will be able to contain the volatility to a far greater extent than if you were more aggressive with this class of assets. You need to embrace equities if you are to benefit from its general upward momentum over the medium term.  


To purchase equities, you will need to open an account with a licensed stockbroker. Alternatively, a passive strategy for you could be to invest through a mutual fund with similar goals to yourself or use a trusted investment advisor to assist in developing a portfolio within your parameters. Next week, we will focus on the asset class of fixed income instruments (eg. bonds).



(Subhas Ramkhelawan is the Managing Director of Bourse Securities Ltd.)


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