Understanding Asset Allocation

by Mark Moir

Correct asset allocation is arguably the most important factor in determining investment returns according to Ian Jones from Fundhouse, an independent Fund Rating Agency.

So what is asset allocation?

Your investments should contain a spread of assets across different asset classes, and include equities (shares on the JSE for example), cash, bonds, property, derivatives and offshore assets. For funds on the Beanstalk platform, the spread of these assets depends on the particular mandate each fund's manager is bound to abide by. For example, the Allan Gray Equity Fund is a single asset fund that contains just equities. On the other hand, the Coronation Balanced Fund contains all of the above-mentioned asset classes.

Different assets carry different risks

The higher the potential return from an asset, the higher the risk of capital loss.

Lower risk funds will therefore naturally contain assets with a lower risk of loss (such as cash and bonds), but are therefore also not expected to yield the same return as higher risk funds. Let's take three of Coronation's funds and look at their asset allocations, historical returns and their maximum drawdown to illustrated this:

Coronation Fund Max. Drawdown (Risk Measure) 5 Year Annual Return Equities Bonds Property Cash Offshore
Balanced Defensive
(Conservative Fund)
-4% 13% 13% 36% 5% 21% 25%
Balanced Plus
(Moderate Fund)
-6% 18% 32% 10% 7% 24% 27%
Top 20
(Aggressive Fund)
-11% 23% 95% 0% 4% 1% 0%
  Best Performer
  Worst Performer

There are various restrictions when it comes to asset allocation, and in South Africa, the most significant restrictions are enforced by Regulation 28. For a fund to be considered for use as a retirement fund, it has to comply with Regulation 28 which restricts the fund's exposure to certain asset classes. The primary restriction in this regard applies to the exposure of a fund to offshore assets, and at the time of writing, funds that wish to comply with this regulation can hold a maximum of 25% of their assets offshore.

So what should my asset allocation be?

There is no single answer to this question. Whatever your asset allocation, it is imperative that it fits with your investment goals and risk appetite. This can be different for every person and every investment. For example, you may be a conservative investor if you are 58 years old and saving for retirement. You may however be a moderately-aggressive investor if you are 35 years old and saving for retirement.

Where do things go wrong?

Inappropriate asset allocations are typically unsuitable because they pose a higher risk to your money than they otherwise should. Let's say you made an investment 20 years ago in a fund with 100% exposure to the SA equity market (the JSE) and have enjoyed decent returns over those twenty years. Let's also assume for the purposes of this illustration that you are now approaching retirement, and market conditions are looking less favourable than they have in the past. An investment with 100% exposure to a) the local market and b) equities, when you can least afford to lose capital, is a recipe for disaster. The risk is simply too high.

The opposite can also be true i.e. you hold unsuitable assets not because they pose a higher risk to your money but rather that they pose too low a risk. In high price inflation environments such as South Africa, this can also be prevalent as inexperienced advisors may have you invested in very low risk funds (such as the money market), but the returns on those funds isn't sufficient to keep abreast of inflation and the real value of your investment erodes over time.

So what should you do?

Sample Asset Allocation

Beanstalk investors have the benefit of a regularly updated asset allocation pie chart model of their investments on their investor dashboard. This allows them (and us as their advisors) a constant bird's-eye view of the asset allocation at both an investment and portfolio level, and allows us to identity risks and over/under exposure to certain asset classes.

A number of new Beanstalk investors have had investments at other institutions and had no idea of their exposure to risky asset classes. On investigation we regularly find many outdated investments that are incongruent with the investor's goals and / or current market conditions.  We typically build an overall asset allocation model for these clients and advise on how best to rebalance their portfolios. We can do the same for you. Simply give us a no-risk, no-obligation call on 021 828 2890 or drop us an email to help@beanstalk.co.za and we will do our best to assist you.

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