BY: EDWIN POTSIWA

Asset allocation decision refers to the degree of spread of your investment across various asset classes and within these asset classes.  The first step is to define your asset classes which are typically stocks (equities), bonds, money market, real estate and pure money market. The more sophisticated investor may include other alternative classes such as actively traded options and futures, currency, precious minerals (such as gold). In selecting asset classes the investor has to consider regulatory issues and the investment policy, objectives, capital available for investments, time horizon and the level of sophistication of the investor. The next step after identifying the eligible asset classes is to set the target weights in the portfolio. A more risk tolerant investor may be overweight in risky assets such as equities and real estate or better still other speculative investment alternatives. Asset allocation decision has a strong bearing on realised returns. Research both in the local and developed world markets show that over 75% of portfolio return is attributed to asset allocation decision.

Investment practitioners use a variety of approaches to asset selection. This is basically reflective of an individual’s investment philosophy and strategy, experience and level of sophistication. A value investor will focus on the business` fundamentals, while a chartist will use a multiplicity of technical analysis for stock picking. A contrarian will decide to buy when the rest is selling. In light of this investors are recommended to decide as part of their investment policy and investment process, what methodology they will use for asset selection. A value investor for example should spell out the ‘tenets’ of his cherished stock. He will set the minimum level of profitability as shown by return on equity, net margins, the maximum level of leverage, the ideal stock will have, the minimum level of liquidity stress the firm will have. Warren Buffet, the father of value investing, for example is not interested in turnaround investments or firms with excessive leverage and will rather prefer a zero geared stock. To be successful an investor should spell out his own tenets. The less experienced investor or one who lacks the time resource can enlist the service of a professional investment adviser such as a broker, analyst, property and real estate manager or fund manager to help in this regard.

Realised portfolio returns is largely attributable to the asset mixes you have in your portfolio hence it is important that you get this right all the time. Once the portfolio structure is set, it is important to carry periodic review of the asset mixes. This will enable the investor to measure performance against a set benchmark and gauge how good the asset allocation decision was and suggest actions for further improvement. The economic outlook and the expected fortunes of the company cannot be overlooked when assessing the current portfolio composition. A hyperinflationary environment will prompt the investor to have a defensive asset mix. Cash counters, currency hedges and low leveraged assets are typical favourites. The investor can consider ranking the potential assets based on the above or any other tenets and be overweight in the best assets. Sometimes the investor correctly identifies the ‘good’ asset, but a poor weight in the asset leads to regrets when the asset shines. We recommend investors to take considerable time and effort in asset allocation decisions to achieve superior results.

Until next week, Invest wisely