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Fidelity - Asset allocation; strategic or tactical?

An effective asset allocation has never been more important than in this post-financial crisis period.

Determining an effective strategic asset allocation is the key determinant of long-term performance but it can be a daunting task with investors facing a bewildering array of choice. The fundamental challenge when setting allocation policy is the lack of certainty about future asset returns and volatility across the investment landscape. If we consider a simple stocks, bonds and cash portfolio, what can we say about likely returns and volatility for the next five years? Or the next 25?

A key point is that our assumptions must reflect reasonable beliefs about the future rather than simply mirroring the experience of the past. It is all too easy to take the last 15 or 20 years of market data and feed it into an optimiser model to come up with a recommended portfolio. However, unless we see an exact repeat of the same financial conditions and returns, this approach is highly unlikely to be optimal.

If we can’t use historical returns as the input for our modelling then what can we do? This is where some hard thinking is needed to create a robust framework for estimating future returns for asset classes. Many people choose to use a risk premium approach when addressing the question of returns. The idea is that investors are compensated for holding risky assets, so that over the long run they receive a greater return than they would achieve in a risk-free asset.

Short term tactics, long term strategy

Our approach makes a clear distinction between strategic and tactical decisions. For the strategic decision, Fidelity models truly ‘long term’ allocations of over 40 years. This strategic allocation provides our framework for investing but to navigate the ever challenging investment markets we need an effective tactical strategy to generate returns or to help protect capital.

Our tactical process looks to exploit pricing opportunities across and between asset classes over the short to medium term. A range of quantitative models are used to provide a backdrop to our decision making process with fundamental judgement applied to reach our final tactical positions.

This conceptually pure approach allows us to look at a portfolio and be very clear about the proportion of the total fund value held in a particular asset class that derives from long term considerations and how much derives from short term tactical positioning. While some investors claim an ‘integrated approach’ we believe this leads to a lack of clarity about exactly what role each asset is playing in the portfolio and how its performance should be judged.

Strategic doesn’t mean static

An investor in their twenties saving for retirement should be able to tolerate a lot of equity risk. Their largest asset, when projected to expected retirement date, is the value of contributions yet to be made. A bear market in equities would allow them to buy at lower prices and profit from the recovery, even if this takes a long time.

An investor in their sixties will not have the same tolerance for equity risk. If they have 100% exposure to equities just before retirement and markets fall significantly there is a real risk they will be unable to make good the damage done, either through a recovery in the market or through increased contributions. This argues for a far more conservative allocation.

So over a 40 year time period, the asset allocation should change from a more growth-oriented (equity heavy) portfolio to a much more conservative (bond heavy) one. Many investors struggle to implement such a strategy unaided, but at Fidelity we have a range of risk profiled multi asset solutions to help them through this journey.

Asset allocation is the key factor in determining the performance and volatility of long-term investments. Deciding on an appropriate strategic asset allocation requires the consideration of a wide range of factors. At a time when markets seem particularly unpredictable, disciplined asset allocation provides a way to generate more consistent returns at reduced volatility by taking calculated risks. The importance of experience and common sense as well as a robust and well-considered approach to modelling should not be underestimated.

For information on the Fidelity Multi Asset Strategic Fund visit:

Steven Edgley, Investment Director Investment Solutions Group - Fidelity, October 2012

Please note that these are the views of Steven Edgley, Investment Director, Fidelity and should not be interpreted as the views of RL360°.


Steven Edgley

Investment Director - Investment Solutions group, Fidelity
October 2012

Please note that these are the views of Steven Edgley, Investment Director, Fidelity and should not be interpreted as the views of RL360°.

360° fund links

A range of Fidelity funds can be accessed through our guided architecture products Oracle, Paragon and Quantum, and also through our PIMS portfolio bond.