What is asset allocation?
To properly perform asset allocation for their clients, practitioners need two types of information.
- A client's financial profile. Clients with more risk-aversion and shorter time horizons need to hold safer, lower-return assets compared to clients with more risk-tolerance and longer time horizons.
- Risk and return projections for each asset class. Asset allocators use these estimates to choose the investments that will maximize a client's return given their risk budget. If the asset class risk and return estimates are wrong, clients could end up with poor returns or too much risk, jeopardizing their goals.
Many asset allocators think carefully about the first question. We think the second question is just as important.
Static allocators don't change with financial conditions.
Dynamic allocators adapt.
These projections, and the portfolio changes they imply, are vitally important to returns. A 2010 Morningstar study estimated that roughly half of portfolio return variances were determined by asset allocation decisions.
At Bireme, we believe strongly in dynamic allocation, and we estimate future returns using quantitative models. Using these projections, we can allocate based on the opportunity set available instead of trailing returns. We try to put our clients in the right assets at the right time, so they get the risk and and return they expect.