Studies have shown that asset allocation is the principal determinant of a portfolio’s long-term investment return volatility. Asset Allocation modeling evaluates a wide variety of asset classes and portfolio style combinations to best achieve a client’s investment goals. The modeling process analyzes different risk parameters with a client’s investment goals in mind, ultimately forming the basis for a well-conceived risk control plan. In accordance with investment policy, the client’s asset allocation should exhibit a return/risk profile that would meet current spending and distribution needs while minimizing exposure to market volatility.
Integrated avails itself of the appropriate investment vehicles, whether in the form of separate account money management, collective or pooled investment management funds (e.g. registered mutual funds), passive investment management vehicles (e.g. index funds or Exchange Traded Funds (ETF)) and complementary or alternative investments (e.g. funds-of-funds, private equity and real assets).
Integrated prepares strategic asset allocation studies that analyze various mixes of desired asset classes. An asset allocation model is used to generate “efficient portfolios” of varying risk levels. (An efficient portfolio is one that provides the highest rate of return for the degree of risk taken. Risk is being measured as portfolio volatility).
Integrated determines which asset classes (including maximum and minimum exposure to each), given their risk and return characteristics and restrictions established in the investment policy, are appropriate for investment in the portfolio. For each asset class included in the study, Integrated creates an expectation of investment performance. The goal of strategic asset allocation is to create a long-term asset allocation policy for the fund. The expectations of investment performance should reflect a long-term investment horizon. The estimates of return and risk should be less sensitive to short-term market conditions and actually normalize the performance relationship between each set of asset classes. Although the process is flexible enough to include different input, Integrated recommends using capital market assumptions based on a combination of long-term historical return data with an expected risk premium component.
Next, given the inputs of return risk and correlation combined with asset class constraints, Integrated develops a presentation that will compare several efficient portfolio mixes to the current portfolio mix. The analysis evaluates the asset mixes in terms of expected return and expected risk necessary to achieve the expected returns. A series of screens are applied that identify those asset mixes that meet certain return criteria. Examples of return criteria may be a minimum expected return or the probability of achieving the target return over the fund’s investment horizon. Mixes outside the risk tolerance may then be eliminated.
The result is an objective evaluation of various asset mixes and a focus on the mix or mixes of asset classes that can be expected to meet Integrated’s clients’ objectives and constraints.