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Allocation

The document discusses the importance of asset allocation for investment returns. It analyzes the performance of major asset classes like stocks, bonds, and real estate over a 5-year period. Within equities, it examines factors like investment style, geographic region, and market capitalization that investors can use to further diversify their portfolio. While small caps tend to outperform, they also carry more risk than large caps. The document emphasizes that seeking professional guidance is important for asset allocation given its significant impact on long-term returns.

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Peter Hodson
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60 views3 pages

Allocation

The document discusses the importance of asset allocation for investment returns. It analyzes the performance of major asset classes like stocks, bonds, and real estate over a 5-year period. Within equities, it examines factors like investment style, geographic region, and market capitalization that investors can use to further diversify their portfolio. While small caps tend to outperform, they also carry more risk than large caps. The document emphasizes that seeking professional guidance is important for asset allocation given its significant impact on long-term returns.

Uploaded by

Peter Hodson
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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(Al)Location, (Al)Location, (Al)Location!

T alk to anyone who has purchased or sold real-estate in any form and they will tell you that it is all about location.
Then, they will likely sound like a broken record as they repeat the old adage location, location, location. Fortunately (for those who are not yet sick of hearing these words of wisdom), the same concept applies to investing, and more specifically, asset allocation. The importance of asset allocation cannot be stressed enough as some studies have gone so far to claim that asset allocation accounts for over 90% of returns over the long term . Simply being aware of the various asset classes and their relative performance can be a significant step towards a profitable portfolio. The five typical asset classes where investors can store capital are cash, equities (stocks), fixed income (bonds), real estate (property, REITs) and alternative investments (commodities, precious metals, collectibles, etc). An investors allocation to these classes depends on their specific situation and is best determined with the help of a professional. Figure 1 shows the performance of these classes (excluding distributions) relative to one another. The best performing asset over a 5 year period has been that of alternative investments (represented by the gold ETF GLD). GLD was chosen to represent alternative investments because it is likely the most owned investment within that class for retail investors. Having recovered well after the recession, the real estate market (represented by a U.S. REIT ETF VNQ) is the second best performing asset over a 5 year period. Bonds and Equities (represented by the bond ETF XBB and S&P 500 ETF SPY) have shown similar returns over the five year term while XBB had significantly less volatility, as one should expect. Some interesting observations/confirmatio ns that one could part with by simply eyeballing this chart are the inverse relationship of gold to the S&P (made apparent around spikes), the seemingly high correlation then divergence between realestate and the S&P 500 and finally the returns of the S&P relative to bonds when considering the risk taken on. When examining this chart and drawing conclusions, it is important to remember that past performance does not necessarily indicate how an investment will perform in the future and that deciding which asset classes you want to put your money in is only half of the battle.
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Within each asset class there are various sub-categories that one can invest in. This is where the retail investor can really tailor the portfolio to their own tastes and outlook. We will concentrate our attention on equities and the various ways to allocate money within this asset class. Once you have determined the appropriate amount to allocate to equities it is important to decide in what and where you will invest. Investment style, geography and market capitalization are three silos that can help provide an investor with direction in where to invest and what to avoid.


Ferri, Richard A. "Planning for Investment Success." All about Asset Allocation: The Easy Way to Get Started. 2nd ed. New York: McGraw-Hill, 2006. 20. Print.
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Value vs Growth: The Eternal Struggle


Not since the Maple Leafs and the Canadiens has there been a rivalry so polarizing or as competitive as that of growth oriented investors versus value oriented investors. Countless studies have been conducted to determine which investment style outperforms the other and the general result seems to be inconclusive with each outperforming in certain situations or markets. More than likely, investors best bet is to stick with a style that they are inherently comfortable with while having some exposure, albeit less, to the other style in order to diversify holdings. Doing so will increase comfort with an investment when it is in the red and help to prevent a knee-jerk reaction. Figure 2 shows the 5 year returns for a value and growth ETF (VTV and VUG respectively). While it appears growth stocks outperform value, one must consider the absence of dividends in these charts and that value stocks often pay a dividend while growth stocks typically do not. The extra return from dividends is what helps to close the gap on growth stocks and ensure that the battle between growth and value investors rages on.

X Marks the Spot


Deciding the geographic location to invest in doesnt need to feel like you are scouring a map for a Pirates treasure. For investment purposes, geographic locations can be broken down into the U.S. & Canada, Europe, Pacific Rim and Emerging Markets. The Emerging Markets have been outperformers in the past but are not without extra risks. Make sure you understand the risks involved in investing outside of North America, especially if it is not a developed market. On top of extra risks, there needs to be an understanding of how transaction fees are charged (sometimes online brokers charge extra fees for international stocks) and how things like dividend taxation are treated. When in doubt, stick with what you know or consult a professional. There are plenty of international ETFs that can allow you to invest globally and capitalize on economic trends while reducing company-specific risks. As always, be wary of the fees these types of ETFs charge.

Go Big or Go Home?
Examining Figure 3 and the Vanguard ETFs representing small-cap stocks (VB) and large-cap stocks (VV), it is apparent that small-caps tend to outperform over the long term. Returns for small-cap stocks are better but also assume significantly more risk. Unless you have comfort with your ability to pick individual stocks, most investors would likely be better suited to an ETF or Mutual Fund in order to get small-cap exposure as there are various additional risks when dealing with these companies compared to large-cap securities. While they are riskier, it is hard to ignore the performance of small capitalization stocks and it is a trend that at least should be noted and stored away by investors.

The above three categories are important characteristics to consider when investing in equities. How detailed and in-depth an investor wishes to go with their allocation strategy is their choice as there are other aspects to consider such as the industries one allocates capital to and the type of accounts you are holding your assets in (i.e. TFSA, RRSP, etc.). If resources are being diversified between all of the

different categories within equity investments, it is important to ensure that you are not over-diversifying and essentially getting the S&P 500. If this is the case, you might as well just flat-out buy the index.
The above is by no means meant (or enough) to give a retail investor comfort with creating their own asset allocation. Given the complexities and effect that asset allocation has on long term returns, it is important that this topic is at least discussed with a professional. Understanding the relative performance of different types of assets can provide the tools to question the what and why of an investment recommendation and even provide an investor with some idea or direction as to where they would like to allocate the money that they have worked so hard for.

Canadian MoneySaver www.canadianmoneysaver.ca

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