Asset Allocation

Having had a couple of chats with subscribers since I published my Digging Deeper article on ways to objectively assess the merits of asset classes (the supplied example being regional, the UK vs China), the feedback and the normal ‘I should have said that’ thoughts prompt me to add some supplementary remarks.

Firstly, I should have offered an over arching reminder that when looking at asset selection, a highest order criterion is the level of diversification that can be achieved.

How can you test that? A quick way is to pick funds in each of the main asset sectors you already own and the one are considering, without too much research (eg use funds you actually have plus the II Ace lists for an example new fund). Then you could build a watch list with equal amounts of each fund. You don’t need to replicate every part of your existing asset allocation, just the main blocks (say those representiing 10% or more) Running an X-ray on that watch list will then reveal the correlation if you look at what I call the ‘staircase chart’ on page 2 of the pdf variant.

There are quicker intuitive ways of checking diversification that come with experience. For example, you will soon work out that adding a UK fund to a European or US fund of similar market capitalisation does not add much diversify, nor will buying a technology fund if you have lots of sustainable equity holdings.

You should also bear in mind what you have worked out in your analysis. If for example, you had decided in late 2021 that interest rates were going to rise from a very low base, you ought to have also worked out that when those rises started to come through, past data suggesting fixed income was inversely correlated with equities would not be much use – the new situation would break that realtionship! If you did not, don’t feel too upset, as it seems large numbers of bankers and multi-asset fund managers failed to work that out, or at least to do anything about it!