Basic Concepts for Asset Allocation

The basis of every modern approach to asset allocation is the insight that the risk of investing decreases significantly if the different investments can be divided between different asset classes.

 

We can distinguish between four fundamentally different concepts:


  1. The conservative investment approach with a basic structure of 30% in stocks and 70% in bonds & liquidity. This structure is based on a conclusion of modern portfolio theory. If stocks are added to a portfolio of bonds for up to 30% of the portfolio, it is possible to increase returns in the long term, without significantly raising the price risk. This structure is attractive, in particular for investors who tolerate only low price fluctuations, but nevertheless want moderate capital growth, e.g. to hedge against inflation.
  2. The Norway model: it is named after the investment strategy of the Norwegian state fund, which invests the oil income of the Scandinavian country for future generations. The basic structure is 60% of the assets in stocks, 35% in bonds & liquidity and 5% in real estate. The reasoning behind this structure is a preference for real capital growth via investment in stocks. Nevertheless, the strong value fluctuations of stocks need to be cushioned by a significant incorporation of bonds and real estate.
  3. The Swensen model (also called: multi-asset approach): it is named after David Swensen, the endowment fund manager at Yale University. He proposed that his fund should be as diversified between different kinds of assets as possible. He recommended the subdivision of a portfolio into 5 to 6 different asset classes of a similar size. For optimised risk diversification, the price movements of the individual asset classes should have low correlations, i.e. should be as independent of each other as possible. Not only conventional forms such as stocks, bonds or real estate, but also other forms like hedge funds, private equity, forests or commodities count as separate asset classes. However, in practice, the risks of unconventional assets have often proved very difficult to control. Therefore, this approach in its original form is suitable only for very skilled investors who are aware of the risks involved.
  4. Multi-strategy (also called multi-style): This approach has been developed from experiences with multi-asset structures. Even within one asset class, very different developments are possible with regard to the performance and risk parameters. Therefore, a risk can be significantly reduced by choosing several uncorrelated investment strategies. At the same time, the single styles have been selected to achieve above-average results within their respective asset class by applying a specific methodology. Examples of such methods, such as value shares, value bonds, growth and stability, are described on our website in the "long-term investing” column. Indexation can also play a major role within the scope of a multi-strategy approach, if indices are not only used to cover the whole market, but to track certain sub-segments, for example sectors, regions or market capitalizations.