Strategic Asset Allocation for Private Investors

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Strategic asset allocation: also possible with ETF

How to construct a portfolio of different asset classes for long-term stability - within the investment triangle of risk, return and liquidity

By Christian Stadermann and Peter Brock, BeeWyzer GmbH

Strategic Asset Allocation (SAA) is explained to every client who places a portfolio management order with a bank or asset manager. The service provider then makes the investment decisions within guidelines that have been agreed with the client. But does everyone really understand what this is all about? Probably not.

So here is a simple and schematic illustration of this core concept of asset management! SAA is one of three working levels in portfolio management, the others being Tactical Asset Allocation (TAA) and Manager Selection (MS). Theoretically, risk management can be considered separately, but de facto it is part of TAA. Here is a brief explanation of all three:

- SAA is used to define the bandwidths within which individual asset classes are allowed to move, something like 30 to 60 percent of the portfolio. The prerequisite is, of course, the definition of the investable asset classes, which can be defined more broadly and granularly (for example: European blue chips, American second-line stocks, Asian corporate bonds). For private clients, it usually remains at the upper level of a few main asset classes.

The SAA should reflect a long-term planning horizon of 5 to 10 years and cover the desired investment performance as well as the risk-bearing capacity and tolerance or liquidity requirements. The classic triangle in investing is always risk, return and liquidity, now increasingly supplemented by the topic of “sustainability”. However, this is often just an additional filter and has hardly any effect on the return; at most, the risk is reduced slightly.

- The TAA stands for the implementation of the investment strategy during the year, i.e. buying and selling, within the SAA guidelines. Indicators from the areas of fundamental and technical analysis, sentiment and flow-of-funds or quantitative orientations are usually used to make and document these decisions.

- MS refers to the selection of suitable investment managers, individual equities, bonds or funds in order to implement SAA and TAA concretely.

Is this all a sensible approach and also useful for private investors? In principle, yes, because anyone who invests without a plan will find it difficult to manage the portfolio appropriately over time, assess and manage risk and ultimately achieve their goals.

Nevertheless, some critical thoughts must be expressed:

- Banks and asset managers usually work with a few standardized basic SAA models (e.g. 5 or 7 risk classes). These will somehow suit many clients, but they are not individualized.

- The SAA is often based too much on the managed securities account alone and not on the entire assets, the entire financial situation. Private investors - like the super-rich who have their own family office - should therefore always keep an eye on their total assets. This is the only way to plan the individual life situations of asset holders over the years (education, career, family planning, retirement, etc.).

- Some managers never take full advantage of the SAA guard rails, which makes the results easier to communicate: if things go well, you were there (hurrah!), even if not to a great extent. If things don't go well, you have (thank goodness!) kept the risk within limits. Of course, top results cannot be achieved in this way.

- Most asset managers are not successful in all areas, some work well in TAA, others in MS. However, only institutional investors generally receive a performance attribution that breaks down the investment success in financial mathematical terms.

- Although SAA is the most important component of investment planning, it is usually overestimated: consultants still frequently talk about a 90% share of investment success, although this always depends on the management approach. And younger studies to individual markets have shown lower values (around 60%). Or: With bad work at TAA and MS, the best SAA is useless ..., but a good SAA always creates a solid basis for any investment success.

How should private investors deal with this?

First of all, they should not focus solely on the SAA from the financial sermons, but take it seriously. In the classic investment triangle, they should establish their own positioning across their total assets in terms of risk, return and liquidity as a holistic and long-term SAA, for example with the help of an independent financial planner or suitable software. Not only return and risk considerations are important here, but also considerations regarding the liquidity structure of the investments. After all, no private investor wants to suffer major losses on distressed sales of investments due to short-term liquidity bottlenecks.

Last but not least, all asset management mandates should then fit into this SAA and risk management should also be considered and implemented holistically. This is because the focus should be less on asset classes, as is usually the case in SAAs for private clients, and more on risk factors. After all, equities are not just a risk factor for me, but also for corporate bonds, convertible bonds, private equity, etc. Without an overarching assessment, the risk assessment is often too low.

Investors who construct their own portfolios, for example with ETFs, should also do so within the framework of their overarching SAA and comprehensively assess both risk and return factors. This may or may not correspond to a classic balanced mandate, in which equities and bonds are in a balanced relationship. Perhaps it shouldn't, because this standard model of the financial industry always assumes that equities represent risk and bonds are generally to be classified as defensive. Anyone who has ever experienced a phase of rising interest rates or held corporate bonds without a rating in the upper A range during an economic crisis has had to painfully experience how wrong this schematic classification is. An analytical approach combined with free thinking and individual positioning should therefore become the second triangle of investment!