Friday, 13 March 2020

Asset Allocation Re-Visited

Asset allocation is one of the most important decisions every investor needs to consider if they are to be successful over the long term. So, with the markets in freefall due to the Coronavirus pandemic, this is probably a good time to re-evaluate asset allocation and attitude to risk.

It’s really a question of looking at the possible options where investments can be placed and deciding what proportion to put in each one. The usual classes of investing asset are :
shares (equities),
government bonds (gilts),
corporate bonds and fixed interest securities,
commodities such as gold and silver,
property and finally,

Furthermore, equities can be divided into several sub-categories - large cap., mid cap and smaller companies, emerging markets, UK based or global.

Diversification by asset class and geography is one of the best forms of risk management.

As can be seen from Ben Carlson’s asset quilt, the fortunes of the various assets vary from year to year and it is impossible to determine which will do well in advance. Therefore, holding a diverse mix rather than just one or two classes in your allocation strategy means you capture an average from all parts of the spectrum.

A good asset allocation is not so much about maximising returns, but more about building a robust boat that will ride out the stormy waters and get you from A to B.

Risk Profile & Volatility

When first starting out on the investing journey, I believe one of the least understood aspects is probably the need for every investor to understand their unique emotional make up and ability to withstand the volatility of the markets and then to match this to the most appropriate allocation of assets taking into account time horizon.

Equities are probably the most volatile class but over the long term should provide the better returns. However, I suggest most people are not prepared to see a large percentage of their wealth wiped out over the course of a single month (or even week!) so it is usually a good strategy to hold a diverse mix of assets to reduce this volatility and therefore stand a better chance of riding out the inevitable storms that come along from time to time.

Successful investing is all about the long term so it is vitally important to be able to ‘stay in the game’ for many years. It is therefore important at the start of the process to find an investment process and strategy that meshes well with your personality and temperament.

This is where asset allocation comes into play. As we have seen over the past few weeks, some assets such as equities and commodities are far more volatile than other more stable assets such as government bonds (gilts). The FTSE 100 fell by over 10% yesterday, its biggest one-day fall since the crash of October 1987. Individual share holdings are probably the most volatile. For example shares in Shell Oil and BP have both fallen in excess of 40% over just the past month.
One month chart for Shell and BP
(click to enlarge)

Investors who invest in 100% equities are likely to get the higher returns over the longer periods BUT are more likely to throw in the towel when their portfolio loses 20% of its value in the blink of an eye…and go on to lose a further 25% over the following year.

In 2003, I came very close to giving up on my investing. My stellar gains from the dotcom period leading up to March 2000 were quickly eroded as the markets fell over the following 3 years. 2001 saw the 9/11 attack on the World Trade Centre, the All Share index fell 15% and the technology index fell by over 40%. This was the worst period for equities since the falls of 1973/74 when there was the oil crisis, coal miners taking on the Heath government and the ensuing 3-day week. The following year, the All Share index fell a further 25%!

With hindsight it was clear I should have sold my investments in early 2000 and repurchased in 2003 but timing these events is almost impossible to achieve. It was probably during this period when I was predominantly invested in equities, that I began to understand the importance of a sensible allocation of assets.

It will therefore be a good idea to have a robust strategy which takes into account our emotional traits and behavioural biases. The journey needs to be planned using a number of sound stepping stones and the first of these will be some attention to asset allocation.

Selecting a plan which contains a sensible mix of equities, bonds and possibly property and then being confident this mix can continue through periods of volatility and market downturns, such as we are experiencing at present, is key to a good outcome longer term.

Some Options

A classic allocation is 60% equities and 40% bonds but there is no perfect solution - everyone will be unique in their tolerance to volatility.  There is probably no such thing as a perfect asset allocation - each person should decide on the best mix, and of course, the mix between different classes of asset can, and probably should, vary over time. As you get older, the time horizon will obviously shorten so many will be looking to reduce equity and increase bonds.

One rule of thumb is to hold the same percentage of bonds as your age - so at age 30 years, it would be 70% equities and 30% bonds. At age 60 years, 40% equities and 60% bonds etc.

Tim Hale, author of “Smarter Investing” suggests 4% in equities for each year you intend to be investing - the remainder in bonds. I would go along with this suggestion but maybe for those of a more cautious disposition who require a more conservative allocation, reduce it to 2.5% or 3% for each year.

Another popular choice is the Harry Browne Permanent Portfolio allocation - 25% equities, 25% gilts, 25% gold and 25% cash. The portfolio is rebalanced once per year to restore any imbalance that has arisen as one asset class does better than another.

Personally, I’m not a big fan of gold, but I can understand why some people will hold a significant percentage in their portfolio as a hedge against currency devaluation. Others regard it as the ultimate safe haven in times of extreme uncertainty such as wars.

One of the benefits of spreading your investments across a number of different asset classes is the reduction of volatility. If you are invested 100% in equities and there is a sudden downturn in the markets, you could easily lose 20% or 30% of the value of your portfolio in a very short period of time - witness late 2008! In May, the FTSE was 6,300 - 6 months later the index had slumped 40% (2,500 points) to 3,800 by November. However, if your investments are mixed between equities, gilts and other fixed interest securities, it is more likely the loss will be more like 10% or 15% which should make it a little easier to ride out the storm.

Whatever allocation you may decide is right for your investment approach, the main point is that you have addressed the issue. Also, I wouldn’t get too bogged down with 2% or 3% in this class and 4% in another - a broad brush is going to do the job and will be easier to manage and rebalance.

Many private investors start off with good intentions, but get sidetracked by the latest trend - with me it was technology shares in the late 1990s and currently fossil-free investments - but it could be smaller companies, emerging markets, commodities and so on, ending up with a dogs dinner of a portfolio.

Work Out Your Mix

First of all, it will to some extent depend on your timeframe - the longer the period, the more sense it will make to have a larger percentage of equities in the mix.

Some people are not very good at assessing the probability of a good outcome - they have unrealistic expectations of what they want to achieve for their level of risk and/or competence. They are sucked in by media stories or discussion boards - time and time again, we read about small investors piling into equities when the markets are near the top and just as quickly become disillusioned when the markets pull back as they always do.

As I say, there are no once-size-fits-all allocation - each will need to settle on their own mix. Of course, when just starting out, its very difficult to know just how you might react to a market correction of 15% or 20%. In his book ‘Investing Demystified’ Lars Kroijer suggests that if investors react badly to market falls, then reduce portfolio equity exposure by 10% - keep doing this until you feel comfortable.


If I were in my 20s or 30s, I could well decide to choose 100% equities, after all, they are the most likely to provide the best return over the longer period. This is asset allocation - its just that I have chosen to allocate 100% to equities. The ride is likely to be volatile but may be OK for those with a strong constitution who are prepared for many ups and downs along the investing journey. Obviously there will be no need to rebalance.

Say I choose a portfolio of 50% global equities and 50% UK gilts  - and say at the end of the year equities have done very well and have increased to 60 % of the total portfolio value. This would mean the gilts now represent only 40%. The idea of rebalancing is to restore the original balance of 50:50, therefore I sell 10% of my equities and reinvest the proceeds into gilts. The overall value of the portfolio has increased but the original allocation percentages are always restored at regular intervals.

I am selling those assets which have appreciated in value, and then buying those that have either lagged or depreciated - it seems a little counterintuitive. If we're in a bull market and equities are going up, you have to sell some equities to buy bonds. It could be very emotionally difficult to do - equities may well continue rising for another year or two -  so I need to be disciplined and try to remove that emotion from the process.

The only sensible reason to do this is because of the investing principle known as reversion to mean. Whilst many forms of investments, including equities, can trade above or below their long term average - often for surprisingly lengthy periods - in the long term, they always move back in line with that average sooner or later.

It's always handy to maintain some cash on the sidelines to take advantage of the large dips when equities can become oversold due to market panic and stocks can be picked up at bargain prices.

To Sum Up

In recent times I have been moving my portfolio away from the balanced globally diverse index funds as I wish to avoid holding fossil fuel companies and the big banks which finance their activities. I have been building my own 'green' portfolio of mainly equities however this was with the full understanding that my portfolio would become more volatile. I have been bringing my investments into line with my values and I have been prepared to accept this trade-off for the knowledge that I am no longer a part-owner of companies that are failing to respond to our climate emergency.

I believe the effects of the current pandemic will take some time to resolve and whilst the sell-off is dramatic, I expect the markets will adjust and recover over time. However, when all is said and done, the “best” strategy for you is the one that you understand, feel comfortable with and importantly, can stick with in good times and bad.

Have a robust investing plan

Be sure the plan takes account of personality

Diversify by asset class and geography

Be patient, stay in the game and keep it simple

Feel free to comment below on your own asset allocation and how you ride out the market storms like we are in at present.


  1. I had worried whether your move to a different investment policy had cost you in terms of diversification. Hopefully it isn't mutually exclusive with maintaining an asset allocation with a risk profile that still allows you to sleep at night?

    1. Yes, the renewable energy and other 'green' investments have obviously been dragged down by the general market turmoil but only an average of 5% to 10% so nothing like the 40% hit on the oil stocks which make up a large percentage of the FTSE 100 which is currently down around 2,000 points so far this year.

      I think having done lots of research in recent months for my book 'Climate Emergency', I would have sleepless nights if I failed to avoid the fossil fuel companies in my portfolio.

      This pandemic demonstrates the fragility in our economic and political institutions. I suspect this episode could well be a dress rehearsal for the butterfly effect that will play out from our failure to address the climate crisis and I think investors need to give some serious consideration to the possibility of a green swan event in the future and plan accordingly.

  2. Hello John Edwards and readers, fantastic blog. We were thinking about developing a web based asset allocation solution page based on financial objectives for a portfolio rather than emotional tolerance. We can't gauge the interest though - so any feedback is welcome.
    There is usually an optimal risk and return pairing for any set of objectives, and as you say above a current asset allocation that corresponds to that risk. That takes a bit of maths and a bit of guesswork for the future. If readers want to know the forecasts for market risk return and correlation, look up JP Morgan Long Term Capital Market Assumptions. The previous comment - green swan - we quite agree with, and to us it has meant in the last three years asking clients to choose whether to select securities with a green swan in mind or not. The split has been 50/50 so far.

  3. Hiya!

    Are there any particular standout performers in your portfolio that have so far pleasantly surprised you in this sell off?

    Good luck going forward!


    1. Thanks Dan.

      "Standout performers" is not quite applicable to any of my current holdings! However, the least worst fallers currently are the renewable energy trusts which year-to-date are down around 8% to 10% compared to 35% for the FTSE 100 and 50% drop for the likes of BP and Shell.

      So, glad to have moved my portfolio away from the fossil fuels over the past year but currently pondering to what extent the other holdings will be dragged down and of course how long all this is likely to last!

      Good luck to all in these turbulent markets and, like 2008/09 however much the markets fall, they always bounce back so stay calm and be patient (but easier said than done!)

  4. Thanks for another great post, really enjoying your blog and look forward to reading your latest book.

    1. Thanks Greg. Let me know what you think of the book in due course.