Asset Allocation

        David F. Swensen is the chief investment officer of Yale University, and has been known to generate good returns consistently over the past decade. In his book I have read, “Unconventional Success”, he states that there are three factors that influences the returns on an investors, namely

1. Asset Allocation
2. Market Timing
3. Security Selection

Asset Allocation refers to how your investments are spread out across the different asset classes, such as equity, bonds, etc. Market Timing refers to when you buy and sell, and lastly Security Selection which company’s stock you select to buy. A study has shown that the factor that plays the greatest part on investors’ returns is Asset Allocation.

The result of this study makes sense to me. The “buy low, sell high” mantra is a no-brainer, but unfortunately I think humans’ brain is not psychologically wired to do that. How many of us did dump in our money during the 2008 crisis buying stocks at low prices? At time of writing, the STI index has hit a five-year high, and how many of us are selling at this five-year high? Due to our greed, wanting to catch the peak, this “buy low, sell high” principle is difficult to apply in reality.

            Next, on stock picking, I mentioned in the previous post that unless you have the time and talent for analysing companies’ annual report, business models, competitive advantage, etc, picking “hidden gems” before their prices have run up is not easy. Only when the price of those companies have risen significantly before people starts to take notice, and of course do what we are psychologically wired to do, and that is to “buy high”.

           

            Moving on to the all-important factor of Asset Allocation, it involves how you divide your investment into different asset classes. The most common being stocks and bonds (Difficult to achieve this in local context, which I will touch on in the next post). There are several other allocation models and I will be introducing two models, which I find are worth adopting. The first is “The Permanent Portfolio” devised by Harry Browne in the 1980s and the other is a mixture of bonds and stocks proposed by local expat Andrew Hallam. I won’t rehash  their strategies here, readers can follow the links at the end of the post to find out more.“The Permanent Portfolio” historical record can be trace back to 1972, and has a decline in portfolio value of 0.7% when the world equity market plunged by 37% in 2008. Similarly in Andrew Hallam’s blog, you can read about how he constructs his portfolio using low cost index funds. You can click on the related links at the end of this post or google them to find out more information.

            What makes the Asset Allocation method works is that you must rebalance your portfolio, once or twice or year depending on preference. It involves selling the asset classes that has risen in value, and buying those that has fallen to return individual asset to their original allocation. This achieves the “Buy low sell high” principle. Do note that this requires discipline to do so. For example , if you were rebalancing during end of 2008, you would be buying into plummeting stock prices. Or if you are rebalancing during this period (Apr 2013), you will probably be selling your equity funds, and putting money in gold!

            Although in Andrew’s blog, he does mention how to implement such a strategy in Singapore’s context, I think there can be certain tweaks that can be made. I will elaborate more on this in the next post.

Related links:
Permanent Portfolio Historical Returns
Implementing SG version of Permanent Portfolio Resource A
Implementing SG version of Permanent Portfolio Resource B
Andrew Hallam's Blog