The importance of asset allocation has been well documented as a major, if not the pri-mary, determinant of investment returns in a balanced portfolio.
As I pointed out last week, it can be perilous to chase past stars as far as sectors are concerned, and this applies to asset allocation too.
A simple analysis shows that, since 1960, the JSE Securities Ex-change has produced super returns (40 percent or more) over any calendar year on fewer than 10 occasions.
The interesting part is what the subsequent years yielded. In most of the following years, a negative or low number (less than 10 percent) was achieved. An exception was the late 1970s, when two good years were followed by a super year, then a good year and then a zero return for the year thereafter. This was a time when the gold price was flirting with US$800 and the local economy was more dependent on the metal than it is today. Oil was also strong, and local inflation rose sharply from about 10 percent to the mid-teens.
Today, we have a reasonably good dollar gold price and a strong oil price, but we have a much lower inflation rate.
I hope I have given you a glimpse of the issues the professional asset allocator has to deal with every day.
So how have our professional asset allocators fared for the three years to September 30, 2004?
Over a three-year period, the average returns for general equity, property, bond and cash funds were 18, 18, 12 and 10 percent respectively.
The average asset allocation fund (prudential medium equity) showed a respectable 13.3 percent return during a period when foreign funds generally declined in rand terms and issues such as foreign exchange regulations, demand for foreign assets by clients and prudential guidelines had to be taken into account. The managers who had the most flexibility - namely, those running asset allocation flexible asset funds - only managed to match the 13.3 percent return, almost to the decimal point. One has to ask whether fewer rules really make the job of asset allocation any easier.
While a 12-month period is too short to make any meaningful observations about the behaviour of fund managers, I cannot resist pointing out that, during a period where the average return from general equity funds was 31 percent versus 24 percent for property funds, and eight percent for bonds and cash, the flexible managers only managed to beat the managed funds by two percent, with a return of 23 percent.
Does this mean the flexible managers did a poor job? There is insufficient analysis of my observations to answer that question, and the returns were good when measured against either cash or inflation.
However, two things seem clear in my mind. Firstly, asset allocation is a tough job, even if you have few or no restrictions as to which asset class you can invest in. Secondly, if you are a private investor, it may be better to do a lot of thinking upfront with your adviser and stick to your plan rather than to chop and change your portfolio amid an ever-changing set of factors that will influence the behaviour of asset classes over the shorter term.
The most successful changes in the asset allocation of your portfolio are likely to be made either because you reach a different stage in your life and risk profile, or when a significant, sustainable macro-economic shift takes place, such as long-term changes in the currency.
Tactical or short-term asset allocation is a tough aspect of investments, even for the professionals.