Strategic Asset Allocation Drives the Majority of Portfolio Return and Risk
"For the individual investor, the asset allocation decision is by far the most important factor in determining returns."
- Sandler report into the UK Retail Savings industry, July 2002
Academic research and empirical evidence both demonstrate that it is the long term, or strategic, asset allocation of a portfolio, not fund manager selection and not market timing, that will determine the vast majority of the portfolio's return and risk. The majority of fund managers will rise and fall with the performance of the asset class in which they participate. Therefore, fund manager selection within an asset class with have little impact on the performance of the overall multi-asset portfolio. Market timing or tactical asset allocation activities are unlikely to add value over time; trading into and out of asset classes increases costs and potentially increases portfolio risk through poor investment decisions.
Finding the optimal asset allocation is made difficult by the variability of asset class returns. History shows that each of these asset classes should, in the long run, provide a premium above inflation, but may produce a loss over shorter periods. The diagram below shows the returns of each asset class, ranked from best to worst, each year: no asset class is a consistent top or bottom performer.
Ranked Asset Class Returns
January 1991 to December 2008
Source: Bloomberg, Frontier Capital Management LLP. Performance based on index returns. Click here for more information. Returns in USD.
At Frontier Capital, we believe that it is impossible to consistently predict asset class performance, a belief supported by much academic research and industry experience. If we can’t forecast the future returns of asset classes accurately and consistently in the short term, then a strategic asset allocation across all asset classes is the best way to ensure that you will reap the long term rewards of each asset class.
For further readings on asset allocation, visit our Knowledge Bank.