ASSET ALLOCATION –
the division of investment money to different asset classes, chiefly equities, bonds, cash and real estate – is a key investment decision. The problem for retail investors is that there’s “no simple formula to find the right asset allocation for every individual,” says Prieur du Plessis, chairman of the Plexus Group.
He adds an investor’s selection of individual securities is secondary to the allocation of assets. “The division among assets is the principal determinant of your investment results.” Someone without specialist knowledge or the help of a financial adviser will probably battle to make an accurate decision about allocation. But there are asset allocation unit trust funds where the fund manager will make the decision. Those are in five categories attempting to address different risk appetites, investment horizons and objectives.
“At inception of the portfolio a base policy mix – namely, the long-term strategic asset allocation of the fund – is established on expected returns,” says Du Plessis. “As the value of assets can change due to market conditions, the portfolio constantly needs to be re-adjusted back to the strategic asset allocation. That ensures the risk and return profile of the fund remains the same.”
However, fund managers can create extra value in an asset allocation fund by taking advantage of certain situations in the market, such as pricing anomalies or expected outperformance from certain asset classes. Du Plessis says such tactical asset allocation decisions are typically short term and once achieved the manager will return to the original strategic asset mix.
However, the important question is how successful managers are at making tactical asset allocation decisions. Research by Plexus Asset Management reveals some startling facts. For example, Du Plessis says the asset allocation funds that can reduce equity exposure to zero – prudential low equity, prudential variable equity and flexible funds – provided little protection against the sharp declines in equity prices last year. “Of the 37 prudential variable equity funds only one achieved a positive return over one year (to 29 February 2009, close to the most recent market bottom). Of the 51 flexible funds only four realised positive returns.”
A further significant finding is that flexible funds, which can allocate 100% of the portfolio to equities, generally underperformed the prudential variable equity sector, which can only invest up to 75% in equities.
Individual fund performance also varies widely. Best prudential variable equity fund over one year had a positive return of 2,7%. Worst performer in the same category was a negative 30,2%. Similarly, best performing flexible fund was a positive 5,1%, worst a
No simple formula for the right asset allocation negative 39,2%.
“Based on these findings, investors must realise the wider the investment mandate and the more aggressively the portfolio manager pursues it, the greater the chance of not achieving the investment objective.”
Du Plessis says it’s imperative for investors to understand the manager’s objective and the investment strategy followed to achieve that. “If you’re uncertain rather choose a fund that has the necessary restrictions in place, in line with an asset allocation that suits your investment objectives and risk profile.”