Strategic asset allocation is simply the process of allocating funds between asset classes to optimise investors’ return objectives and risk tolerance with a long term time frame. It is perhaps the most important, but one of the most overlooked aspects of wealth management.
The core of asset allocation is diversification. If you spread your investments across different types of assets, you can smooth out higher and lower return variations that occur through an economic cycle.
The four main asset classes are Equities (shares), Income Assets, Property and Cash. Within Income Assets we include Listed Income Securities (hybrids), Government Bonds, Corporate Bonds and Term Deposits.
Asset allocation in the current market environment
A pickup in global synchronised growth provides a bullish backdrop for investors as we head into 2018. However current economic conditions do remain somewhat unique. They appear to be supporting a ‘Goldilocks scenario’ whereby global growth is becoming entrenched, yet low inflation and very low volatility sees central banks in no hurry to accelerate interest rate normalisation.
However we are also conscious that these conditions are also prone to breeding complacency. We remind investors to remain vigilant as such ideal conditions are unlikely to persist uninterrupted through 2018 when we consider 1) valuations; 2) geopolitics and 3) interest rate normalisation.
Markets are currently in the process of pricing in higher interest rates, which has seen a sell off recently in overseas and domestic shares. Expectations are beginning to shift off of a very low base and low expectations of inflation in the United States. The U.S. labour market at ‘full employment’, capacity utilisation at pre-GFC levels and higher energy (oil) prices all exert upward pressure on inflation, supporting Central bank rate forecasts. Higher interest rates usually signal a close to a bull market, so investors should be conscious of the potential impact to market volatility.
Valuations across most asset classes are expensive, arguably pricing in the pickup in global growth, and are therefore vulnerable to unexpected and/or adverse shocks. This is compounded by the fact that market behaviour implies very low levels of concern about prevailing risk, as evident in ultra-low volatility.
Upside risk to interest rates globally will challenge income-oriented asset classes such as property, government bonds, and long duration fixed interest securities, especially as valuations remain elevated. We therefore are currently underweight by roughly 6 per cent towards income assets and property. We do however have a positive tilt of roughly 4pc towards equities as global growth gains momentum and a higher than normal cash tilt for insurance against known abnormal market risks.
- Boh Burima, Financial Adviser (Authorised Representative: 000341081) Morgans Financial Limited | ABN 49 010 669 726 | AFSL 235410