Passive investing – where an investor aims to match the return on an underlying market rather than beat it – has grown relentlessly in popularity over the last two decades. Little wonder. Passive funds cost far less than actively managed ones and mostly deliver better performance, because only a minority of active funds beat the market over time. Now index provider MSCI is working on the “ultimate index” – a project that “could mark the culmination of half a century of academic theory and practical financial engineering”, writes Robin Wigglesworth in the Financial Times. It aims to benchmark not just equities or bonds, but also “commodities and even private assets that do not trade on an exchange”.
A tracker fund that offers exposure to every major asset class sounds a convenient way to take the headaches out of asset allocation (see below). But as the man behind it, former theoretical physicist Peter Shepard at MSCI, points out, “one size will not fit all investors”. Asset allocation has to fit each individual’s circumstances: risk appetite and time horizon being the two main variables.
MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
Sign up to Money Morning
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Any other asset class you can think of slots into one of these boxes. If you decide private equity is something you want to own (perhaps via listed private-equity funds or investment trusts), it just sits in your equity allocation. It’s the same for commodities – while you can get direct exposure (see page 18), the reality is that mining stocks are a good enough approximation for most of us. As for currencies, they aren’t a separate asset class – they are better thought of as a potential cost you should be aware of when investing in non-sterling assets. Meanwhile, if MSCI or another index provider ever does come up with the “ultimate index”, you could always use it as a benchmark with which to compare your own portfolio’s performance.
Asset allocation is the process of dividing your portfolio between different asset classes, such as shares, bonds, property, cash and gold. Each of these asset classes should behave in different ways in different scenarios and have different potential risks and returns. The aim of asset allocation is to blend these together in a way that produces a combined level of risk and return that best suits an investor’s needs.
To take some extreme examples, a young investor saving for retirement a long way in the future and prioritising maximum growth above everything else might have 100% in shares, while a retiree who only cares about achieving a steady income might have 100% in bonds.
More commonly, somebody who wants to achieve a combination of income and growth while also protecting their wealth from bear markets would typically have a portfolio split between different assets classes in a more balanced way.
I wish I knew what asset allocation was, but I’m too embarrassed to ask
Asset allocation is often divided into strategic asset allocation and tactical asset allocation. Strategic asset allocation is essentially what we’ve already described – how you allocate your money for the long term to fit your investment goals. Over time, the amount in each investment may drift away from your strategic asset allocation because some asset classes have performed better than others. So on a regular basis – maybe once per year – you will rebalance your portfolio to take it back to your original strategic asset allocation.
Tactical asset allocation is any temporary changes that you make to a strategic asset allocation as a result of current market conditions. If shares sell off a long way and now look cheap, you might choose to reduce the amount of cash you hold and increase your investment in shares. Profiting from tactical asset allocation is harder than it sounds and doing it too much can easily lead to higher costs and lower returns.
-
Reeves urged to axe stamp duty from UK shares held in an ISAChancellor Rachel Reeves is reportedly considering axing stamp duty from UK shares held in stocks and shares ISAs. What could it mean for your portfolio?
-
Family investment companies explained: how the ultra wealthy shield their money from the taxmanWealthy families are increasingly turning to family investment companies to keep more of their money away from HMRC – but what are these arrangements and how do they work?
-
Cash in on the vast growth potential of the companies electrifying the worldOpinion Martin Todd, portfolio manager, head of sustainable equities, Federated Hermes, highlights three electrification companies where he'd put his money
-
Galliford Try has firm foundations for strong growthBuilder Galliford Try has a finger in a wide range of pies, notably important work in the public sector
-
Card Factory is a stand-out small-cap going cheapIn a digital world, we still value the personal touch. That’s good news for Card Factory, whose unique business model is suited to weather all economic storms
-
How much gold does China have – and how to cash inChina's gold reserves are vastly understated, says Dominic Frisby. So hold gold, overbought or not
-
How to invest in undervalued gold minersThe surge in gold and other precious metals has transformed the economics of the companies that mine them. Investors should cash in, says Rupert Hargreaves
-
Debasing Wall Street's new debasement trade ideaThe debasement trade is a catchy and plausible idea, but there’s no sign that markets are alarmed, says Cris Sholto Heaton
-
New faces don’t solve old problems – why strategy also matters when it comes to investment trustsOpinion Changing managers often fails to boost a trust’s performance, says Max King
-
How to profit from silver’s record riseSilver often lets investors down, but there may now be room for further gains, says Dominic Frisby
