ASSET ALLOCATION 





An Interview With Philip S. Wilson


Q.What is asset allocation?

A.Unfortunately asset allocation seems to mean many different things to many different people.  It is not the simplistic approach of shifting money between cash, 
equities and bonds, or hedging equity or bind portfolios using futures contracts.  It is the allocation of capital to diverse asset classes to maximize returns within specific 
risk parameters.  The object is to construct portfolios which will achieve the highest possible returns without exceeding the investor's tolerance for risk.


Q.Why should investors use asset allocation?

A.Investors are not, and indeed should not be, looking for simplistic or pat answers to their investment needs.  They are risk averse and don't want advisors who 
"shoot from the hip", or "read a lot and guess".  They do not want special situations or short-term solutions to their long-term objectives.  Several academic and industry 
studies have demonstrated that the efficient allocation of capital using the techniques employed in asset allocation models can greatly improve the probability of achieving 
higher long-term rates of return while maintaining reasonable levels of volatility (risk).


Q.You mention improved performance.  How would that be achieved?

A.Most investors acquire investments without much, if any, consideration for expected rates of return, risk, and the inter-relationship or balance of the assets 
involved.  They generally end up with a mix of unrelated investments which, taken as a whole, can never fulfill the investor's policies and objectives.  They need portfolios 
which are designed to match assets according to risk/return tradeoffs.  Such portfolios would include assets which rise in value as others decline in value.  If capital is 
allocated efficiently to a mix of well balanced investments, portfolio returns will generally be higher over the long-term and portfolio volatility will be lower.


For example, most investors don't realize that long-term corporate bonds have had lower rates of return and higher volatility than growth & income equities over 
the past 15 years.  By simply shifting some percentage of the portfolio from long bonds into growth & income equities or shorter term bonds, investment performance 
could be improved as risk is reduced.

Q.How can these methods better manage risk?

A.The basic need of any investor is to preserve capital, or at least achieve reasonable rates of return without risking unacceptable amounts of capital.  These 
methods quantify the expected returns for current and proposed portfolios and they measure the risk the investor is taking in absolute terms.  The ability to tell an investor 
that he might lose 6.0% of his principal in any 12 month period (real or nominal) is a quantum leap from saying that his risk is "moderate" or "aggressive".  The use of 
such terms makes it virtually impossible to evaluate the risk/return characteristics of a portfolio in any meaningful way.


By knowing the level of risk an investor is willing to accept in absolute terms, we are able to construct portfolios which should exceed expectations.

Q.How does asset allocation improve diversification and liquidity?

A.Diversification is not a very well understood concept.  Most investors think their portfolios are diversified in they own 100 different stocks.  Actually, owning 100 
different stocks does not reduce the systematic risk of a portfolio any more than owning 20 stocks across industry lines.  True diversification can be achieved if you own 
two or more assets which have a negative, or nearly negative correlation to each other.  Basically, this means that when the value of one asset is declining, the value of 
the other asset(s) should be rising.  Asset allocation techniques measure the relationship between investments in order to construct a more balanced or diversified 
portfolio.


Q.OK.  Asset allocation is a valid and useful concept.  Does it work in the real 
world?

A.Asset allocation techniques are currently in use by most banks, insurance companies, financial planners, investment advisors and institutional investors.  In fact, 
in a study recently conducted by our firm, we found that over the past 20 years asset allocation (portfolio optimization) outperformed a static or re-balanced portfolio by 
approximately 4% and 3% respectively.


Our firm takes an objective and very scientific approach to designing and managing client's portfolios.  We employ the most advanced investment technology currently 
available and work closely with clients in establishing formal policies, objectives and acceptable risk parameters.

If you would like to know more about our firm and the asset allocation process, please call for an appointment.


Respectfully,


*Philip S. Wilson is president of Advisoryworld 

a firm which specializes in developing portfolio optimization 
techniques and strategies.  He is in Barron's Who Who as a 
recognized international expert on asset allocation and portfolio 
optimization methodologies.

AdvisoryWorld.com