By Rob Starkey, Portfolio Manager, Schroder Investment Solutions
Strategic asset allocation (SAA) is a cornerstone of investment management. This policy decision sets the foundation of an investment portfolio and guides the investment decisions.
The role of Strategic Asset Allocation
SAA is the long-term systematic approach to diversifying a client’s portfolio across different asset classes, based on their financial goals, risk tolerance, and investment horizon.
The primary role of an SAA is to set target allocations for various asset classes in a portfolio, and periodically rebalancing back to these targets.
The core principles are:
- Diversification: by spreading investments across different asset classes such as equities, bonds, and alternative investments, investors can mitigate the risk associated with any single asset class.
- Risk management: different asset classes have varying levels of risk and return. Carefully allocating investments across asset classes, investors can manage their exposure to market volatility and potential losses. This is crucial for risk-profiling and setting a return expectation for financial planning.
- Discipline: it helps avoid impulsive decisions based on market noise and instead focus on long-term investment objectives. Having an investment plan is only good if we can stick with it for a full investment cycle.
Should these merits of a diversified SAA be challenged?
A challenge for many investors who implement an SAA, is being underweight the US for diversification and valuation reasons. This has caused some pain from missed returns as other countries have lagged in performance compared to the US. Investors may now be asking themselves if this US underweight is sensible and whether they should reduce or remove allocations to other regions and focus more to US stock markets.
15-year cumulative daily return for country equity indices (GBP)
After seeing the above extreme outperformance of the US stock market compared to other regions over the past decade, we can understand why an investor may feel that diversification has failed them if the US has delivered the best returns. Another complicating factor is that – thanks to the outsized relative returns – the US is now nearly 65% of the global stock market, making it difficult to have a small exposure. Allocating less than a third to the region, even for sound risk management and long-term return expectations, poses a risk that short-term underperformance can occur if the US continues to have strong performance.
The devil in the detail
There is no doubt that the US has had an exceptional run over the past ten years, but such periods can generally only be known with the tremendous clarity of hindsight.
Even if the US economy is performing well, the stock market and the real economy are not identical. Similarly, there is a difference between a good company and a good investment. Even if a company commercially performs well, there is ultimately a price at which no matter how well it performs, you might still not make money as you paid too much to start with. We are not implying that you cannot make good investment returns from the US, but we are aware of overpaying and getting the odds wrong.
Additionally, there is always a theme driving global markets one way or another, and these themes lead to certain companies being prized for a period. Right now, the US is dominating the narrative, but history shows that leadership of the stock market changes through time and no one single company dominates. This can be looked at for both countries and stocks. In the 1960s and 1970s, the US had a higher weight of the global stock market than it does today, but it decreased to nearly 30% by the 1990s; a good reminder that one theme is never permanent.
Nominal equity return forecasts compared to the previous year
Within the US market itself, snapshots of the top 10 largest stocks at various points over the past 20 years, shows that leadership of the market changes over time. This is despite how permanent a trend feels in any given moment. There is an exception to every rule, such as Microsoft, but clearly, there is no permanent winner. This is why it is important to consider what is expected based on fundamental trends, to acknowledge that things cannot continue in a certain direction forever (but can happen for longer than initially expected), and lastly, to respect the quote that the only constant is change.
What have we seen versus what do we expect?
Our Economics and Strategy team invests a large amount of time and resource trying to answer the question, what is next? Their annual 30-year forecast paper places the long-term expected returns for the US into the context of what can be expected from other regions. The challenge is balancing the interim shorter term return strength of the US against the long-run expectations based on fundamentals.
Adjusting our Strategic Asset Allocation
While SAA is relatively stable, it‘s not static. At Schroder Investment Solutions, we update our SAA annually to reflect the structural shifts playing out. Asset allocation should evolve as markets change and as investors’ goals, risk tolerance, and time horizon change. Additionally, setting your SAA should be a forward looking, longer-term exercise, allowing for a full market cycle to play out.
Concluding thoughts
Strategic Asset Allocation plays a crucial role in investment management. It is a tool that helps investors manage risk, achieve diversification, and work towards their financial goals. As the economic environment changes and long-term forecasts are updated, it’s important to review and adjust the SAA accordingly.
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About Robert Starkey
Portfolio Manager, Schroder Investment Solutions
Robert joined Schroders in May 2021 and co-manages the Schroder Investment Solutions range of products. He started managing multi-asset model portfolios and funds in 2013, and has experience in both the South African and UK markets. Robert is a CFA Charterholder, holds the CIPM designation, and has passed the CFP examinations. He holds degrees in Economics (Cum Laude, undergraduate), Financial Planning (First Class, honours), and Investment Management (Distinction, masters).
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