What you need to know about new norms for asset allocation

Asset allocation used to be relatively simple – think property, some fixed term deposits and, of course, equities. Life – and investing – has become a lot more complicated since then and determining the asset allocation in your portfolio requires deeper thinking.

If there’s one key takeout for setting your asset allocation, it’s that you shouldn’t automatically steer for 3-4 traditional assets.

“I think being really clear. What is your investment thesis or rationale? Write it down ideally and periodically go and revisit it. 

The second point – thinking about the potential upside but also downside risks,” says MLC Asset Management’s Anthony Golowenko.

Finally, he suggests investors adopt “a continuum or full spectrum thinking around asset classes”.

Golowenko walks the talk in MLC's portfolios. His asset allocation is currently:

• underweight global equities (having moved some unhedged exposure to emerging markets)
• overweight credit (investment grade and sub-investment grade)
• overweight alternatives
• underweight Australian shares - particularly mid-caps.

A newer focus has been towards real return, with Golowenko noting that "things like insurance-related investments and opportunistic growth strategies are delivering strongly within our real return fund."

You can't stay static in your allocations either, with Golowenko having recently shifted the credit exposure across all maturities. The exposure previously centred on short maturities in response to the rapid interest rate rises. 

In this episode of The Pitch, Golowenko discusses modern asset allocation and his approach. He also discusses the ranges to consider and how frequently investors need to consider rebalancing.

This interview was filmed on Wednesday, 3 April 2024.

Edited transcript

What are investors getting wrong when it comes to asset allocation?

I think in a nutshell, the three things. Adopting a traditional approach with traditional indices and a traditional mindset.

We think delving a bit more deeply into asset class and sub-asset classes and rewriting some of those rules can lead to superior outcomes. But ultimately investing is inherently simple. We're deploying capital at some level of risk for an expected outcome over an appropriate time horizon at what should be an appropriate fee level. And just those combination of those things come into constructing those portfolios.

Why should optimal modern asset allocation look like compared to the past?

Traditionally, let's go back 25 years, so you might have residential property, term deposits and Australian shares. Now that's done quite a good job at delivering for investors. Where we are now and the breadth and full continuum of opportunities, we think there's a lot more to be done and more asset allocation levers to pull by delving a bit more deeply into those asset classes.

Australian equities for example: what are largely income orientated with franking credits, homogenous lending machines in our major banks, that's a growth asset class. Then a sub-asset class approach, like smaller companies would be more growth orientated and which might be a balance between the small and large caps. Then stepping away from that, thinking more about what the role is and purpose and how that contributes, we think about that as our approach.

What typical ranges for asset allocation might you see in a balanced portfolio today?

There are four ranges in our managed account strategies. A conservative 30% growth, moderate 50%, balanced 70%, growth 85% and high growth 98%. Conceptually we could swing those by 20% and in extreme cases, more on the risk side of things, we would be in a position to do so.

In practice, with an investment committee governance, that range is more like plus or minus 10%. That's at an asset class and sub-asset class level. And why do we have those ranges? It's somewhat obvious, we have those to allow investment views, asset class and sub class levers to be part of the portfolio. This gives that flexibility for active management with strong advocates of that.

How frequently should investors be thinking about rebalancing or adjusting their asset allocation?

At the high level, those big punchy asset allocation calls and changes we’re been running in our managed accounts program for coming on four years. We would expect those wholesale changes every two to three years. It’s got to be around something major.

We were thinking about our short maturities within fixed income, allocating that to longer maturities, building out credit and getting a bit more resilience with global equities through emerging markets. Also, building out some flexibility in the real return components of the portfolios by including alternatives.

Probably every two to three years for those big calls. For refinements, perhaps two or three a year. Then, from a hygiene or discipline side, where you are getting that natural drift or deviations pushing out. For our portfolios, we’re monitoring from 2% but at a 3% level, we start to bring it back to an inner band. Those are our rules of thumb around asset allocation ranges. You want the flexibility but at the same time, you don’t want to be over at the controls madly tinkering with portfolios. You want to try and be parsimonious.

What three rules of thumb would you recommend investors use when it comes to asset allocation?

I think being really clear. What is your investment thesis or rationale. Write it down ideally and periodically go and revisit it. In the second point – thinking about the potential upside but also downside risks. And to my earlier comments around the distribution of potential outcomes in theory and in practice are actually going to be quite wide. The third one is adopting a continuum or full spectrum thinking around asset classes. We’re got this whole world of opportunities, go out there and grab them.

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MLC Asset Management's portfolios combine their best thinking on asset allocation with a disciplined investment process - developed over 35 years - that optimises returns and reduces risk. For further information, please visit their website.