Asset allocation matters – but which assets should you hold?

Many studies suggest that asset allocation is a far more critical driver of long-term investment returns than the underlying holdings in your portfolio.

In other words, you can afford to make quite a few mistakes in selecting, say, individual stocks, as long as your overall portfolio is not too heavily exposed to equities.

There are four asset types that I use within client portfolios at my asset management business.


Bonds represent ‘ground zero’ in the current financial landscape. With several countries effectively bankrupt, you should choose your bond investments – if any – with extreme care.

The interest rate cycle is slowly starting to turn back upwards. This is hazardous for bonds, whose prices invariably fall when interest rates rise, because conventional bonds have fixed coupons. The value of these fixed payments becomes less attractive when interest rates are rising. A 5% coupon looks nice when interest rates are at 0.5%, but it’s not so hot when they’re at 7%.

Eurozone interest rates have already started to tick up, with the European Central Bank finally remembering that it has an obligation to try and control inflation. For investors in the US and the UK, no such luck. The economies and financial systems of the ‘Anglo-Saxon’ economies are so fragile, it will be surprising if monetary policy rates rise at all this year, even though they should, given the devastating impact of inflation upon savers.

High-quality equities

Obviously, these come with a degree of price risk. But there are really two types of risk that will affect our portfolios, and only one is a long term threat.

Day-to-day price volatility is a function of any investment once you venture outside the realm of cash deposits. That is a simple fact of life. The market ebbs and flows. If you are a regular saver, market volatility can work in your favour. If the market trends down, and you have decided to allocate a fixed amount of capital to investments on a regular basis, lower market prices will give you greater buying power during downturns. Such ‘pound cost averaging’ is almost certainly a better route than trying to time the market.

The sort of risk you should be most concerned by is the risk of a catastrophic loss of value – the loss of permanent capital. For this reason, I have a natural tendency to favour more defensive / high quality equities, where I consider that this risk of catastrophe is massively reduced.

One of the best metrics I have found for identifying relatively ‘safe’ equity investments is the Altman Z Score. While the investment environment remains fraught, I’m convinced that a selection of well-chosen and high-quality equities stands an excellent chance of preserving real wealth over the medium term, and acting in part as an inflation hedge.

Absolute return funds

These are not an asset class per se, but more of an objective. I use them because I like to be diversified against market shocks. A good absolute return fund manager has an explicit mandate to generate a positive return irrespective of market direction – and in many cases has the track record to prove it.

In some instances, absolute return funds can be hedge funds, which are widely shunned by individual investors and their advisers on the grounds of cost. But what really matters to any investor is the net, after-fee return. I’m happy to pay what might look like very expensive fees to third party managers, provided that my net return is still a decent one. Fees are a complex part of the asset management business. Buying cheap does not guarantee happy outcomes. Sometimes, it pays to pay up for quality management.

Real assets

These are effectively non-financial, tangible assets. Gold and silver still represent the lion’s share of the real assets component of my portfolio. And they will do for as long as our monetary authorities continue to believe that printing money will sort out the world’s problems. It will not. For as long as the world’s paper currencies (and notably the dollar) continue to be degraded by central banks and state Treasuries, and for as long as most governments continue to run colossal deficits and national debts, it will make sense for investors to retain exposure to ‘stateless’ monetary assets such as gold and silver whose prices cannot be manipulated to order by government.

But it doesn’t end with gold. Agribusiness investments also make sense, and I am actively looking for appropriate vehicles in timber, forestry and commercial property as and when the right opportunities, in the right structures, arise.

A few final thoughts. From an analytical perspective, there are always two ways of assessing the markets: ‘top down’ and ‘bottom up’.

Top-down investing is also known as ‘the fundamentals’. It makes sense to give some consideration to the macro picture, but this is always subjective, and therefore prone to error. More to the point, there have to be limitations to any process of predicting things which will never be fully predictable. Or in the words of Voltaire: “Doubt is not a pleasant condition, but certainty is absurd.” If we have ever lived during conditions of uncertainty, we are doing so now.

Bottom-up investing, by contrast, considers the individual fundamentals of specific investments, companies and their stocks, for example. Bottom-up analysis normally works, but when it goes wrong, it can go horribly wrong.

Bottom-up investors in equities, for example, had to contend with a vicious bear market in 2008 which saw value stocks and growth stocks alike get destroyed by forced selling – flying in the face, in other words, of the fundamentals.

So you stand the best chance of a successful investment outcome by conducting both forms of analysis. Some form of roadmap for the future helps, provided the underlying analysis is broadly sound. And bottom-up consideration helps to sort the wheat from the chaff.

I’m convinced that, within this context, taking this well-diversified, four asset-type approach gives any investor sufficient flexibility for whatever their time horizons, income requirements and individual risk appetites might be.

• This article was first published in Tim Price’s fortnightly newsletter, The Price Report.

Find out more about the Price Report here


  • Tom Roundhouse

    A good article.

    Re the value trap, I have seen fund managers hold onto positions even though they ended up losing 80% of investors’ money. When challanged one manager said: “I still think it is a good company and it is only a small position”. I guess he would have been even more unwilling to admit being wrong if it were a large position.

    As regards Absolute Funds, these have become flavour of the month but if you want an example of an outstanding one, look at the CF Ruffer Total Return. Ruffer had this fund up and running long before lesser mortals started to climb onto the bandwagon. If ever a fund did what it says on the tin this is it. For a laugh run the FTSE alongside it.

    Happy days!


  • DST

    Finally someone at MoneyWeek who has the sense to realise fund fees, although definately a consideration, are not the be all and end all of choosing an investment fund.
    It is indeed as you say the net return that the fund produces for you.

  • adam

    So, as an example and to make the above more useful, what splits would you recommend for a typical portfolio of say low, medium and high risk.

    Seeing as otherwise none of the above is news. Asset allocation is well know and well practiced even amongst novices like myself – it is surely the split [current of course, you can rebalance] decides how successful the strategy is?

  • TomJefs

    I hold no bonds. Never understood conventional thinking on them. Their performance have never been worthwhile even as a diversifier.

    As for absolute funds, again mediocre performance at best for most and obscene fees make this a non-starter.

    In sum, the allocation recommended in the article will not give great returns will it? Need to narrow down the assets to make it worthwhile otherwise don’t take the risk at all and just hang on to inflation-sapping cash.

  • Tim Price


    In reverse order,

    The asset allocation I use in the newsletter (and for my clients) is primarily designed to preserve capital and generate a meaningful return consistent with that first objective. It is expressly not targeted at maximising returns given that that isn’t my aim. Our clients are wealthy and our primary focus is helping them to preserve that wealth, in real terms.

    The best absolute return funds have a role to play. The best managers are worth paying for; it’s all about the net return, so I disagree that fees are obscene. If someone can generate consistent annual returns in double digits, say, after fees, I’m not overly fussed about the fee load.

    As to bonds.. with cash yielding nothing in real terms and equity markets struggling, what are the alternatives ? High quality bonds delivered good positive returns in 2008 and I expect them to repeat that experience in light of the severe deflationary problems affecting the global economy and asset markets.

  • Phil Parry

    What about property? Doesn’t some capital have to be in that to be truly diversified?

  • DST

    Surely property comes under Real Assets.

  • TomJefs


    You don’t seem to have much faith in stock markets or have a strategic vision. Bonds’ real return is negligible and absolute return funds either underperform the market or their fees erode real returns. Only a lucky few might perform in the short-term only. And individual shares are beset with high risk. Just look at BP.

    My advice to preserve wealth is to keep fees low, assets tight and investments with strong market coverage. Therefore, the supercycle of commodities is compelling, ETFs and index trackers with broad market coverage, and emerging markets have both healthier balance sheets and better company growth prospects. Property is a solid income generator and diversifier.

    I invest in XWXU, GWX, XMEM, JPM Nat Res, IWDP, Inv High Inc, GBSS. A solid preserve capital portfolio that fits with your goal.

  • Phil

    As an IFA who needs to select asset allocations for real clients rather than from Moneyweek’s perspective of just making recommendaions is very different. Making investment decisions for clients is difficult to say the least in today’s market. There are a number of real/total/absolute return funds that are excellent. Baring Absolute, CF Ruffer Total Return, Distinction’s Real Return, Insight Absolute, Newton Real Return as well as a number of others are all worthy of consideration. If you consider the fundamentals i cannot remember a time where they have been so negative and as a result to have ‘Hedge’ funds that can make money whichever way the market goes at the centre of portfolio’s seems to make common sense. You can argue all you like about inflation or deflation but a good fund manager who makes money whatever happens for me, as someone who actually has to make decisions with real client money, is a simple decision.

  • TomJefs

    Oh come on, Phil. I do wonder if you are just justifying your job.

    Those fund managers who you have faith in are not aligned to your clients interests. They get their fees (like you) either way. When seasoned pros like Stanley Druckenmiller retire because they think beating the market is too hard and when finding star managers is like trying to find a needle in the haystack you have the evidence stacked against you. Bogle is right. Fees and turnover matter far more than tinkering and tactical “hedging”. I pity your clients.