Strategic Asset Allocation
When thinking about investing, we often think about sector allocation, security selection, growth vs. value and such. But there is an important over-arching question that many believe to be the most determinant factor in ultimate results… that factor is strategic asset allocation.
Asset allocation is a macro investment strategy that aims to balance risk and reward by apportioning a portfolio's assets according to an individual's goals, risk tolerance, and investment horizon. Another way of thinking about these three aspects is in the form of questions: “Where do you want to be?” (goals), “How do you want to get there?” (risk), and “When do you need to get there?” (horizon).
The three main asset classes are equity, bonds, and cash and cash equivalents. Each of these has different levels of risk and return, so each can be expected to behave differently over time. Traditionally, stocks offer the largest potential returns but they also experience more volatility, i.e., “ups and downs”, than the other classes. Bonds can offer greater security and stability to portfolios, but typically at the expense of stocks’ upside potential. Cash, which hasn’t offered much of a return until the past year or so, has the benefit of providing increased liquidity and can act as “ballast” in portfolios to help offset riskier assets.
The Importance of Strategic Asset Allocation: Four Historical Examples
In the accompanying video, MONTAG Portfolio Managers Randy Loving and Chris Guinther talk about the importance of asset allocation. Moreover, they use historical examples from the past 25 years to illustrate substantial pullbacks in the equities markets and the recoveries that ultimately followed. Investing veterans themselves, Chris and Randy experienced these movements firsthand during their careers and can speak with the benefit of that experience. Specifically, Chris discusses 4 examples:
- The bursting of the “Dot-Com” technology bubble of 2000: Stocks down 50%, technology stocks down 80%
- The Great Financial/Housing Crisis of 2008: Stocks down 50%
- 2018’s 4th quarter pull-back in stocks in anticipation of interest rate hikes: Stocks down 25%
- The Covid pandemic of 2020: Stocks down 35%
Randy Loving mentions the speed and availability of information, which the more recent examples highlight relative to the earlier two – when leading indicators took longer to become clear. The effect can be to shorten and compress the duration of market pull-backs, and Chris Guinther observes “The market learns from itself.”
How Much Risk is Too Much?
For portfolio managers, the question comes down to this: “How much risk can a client stomach… how much in the way of losses can they handle?” Investors with a 10–, 15–, or 20-year time frame should assume the stock market will experience a 50% decline at some point along the way. “How much money do you need to protect, preserve, and conserve when the tanks are in the streets?” Chris asks rhetorically. Randy points out the importance of sticking around for the recoveries, which followed each of the 4 examples above. “Our job is to help clients not to panic and to remain in the market to achieve the upside” associated with the following recovery. “We assume there will be a recovery always,” Chris Guinther observes, citing the free markets and capitalistic system in the U.S.
Hear MONTAG Portfolio Managers Randy Loving and Chris Guinther in their own words by viewing the accompanying video.
The information provided is for illustration purposes only. It is not, and should not be regarded as “investment advice” or as a “recommendation” regarding a course of action to be taken. These analyses have been produced using data provided by third parties and/or public sources. While the information is believed to be reliable, its accuracy cannot be guaranteed.
Any securities identified were selected for illustrative purposes only. Specific securities identified and described may or may not be held in portfolios managed by the Adviser and do not represent all of the securities purchased, sold, or recommended for advisory clients. The reader should not assume that investments in the securities identified and discussed were or will be profitable.