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September 23rd, 2020

The Secret to Unlocking Value in Asset Allocation

By Sanjoy Chatterjee, Chief Strategy Officer

Asset allocation is the foundation to constructing and optimizing an investment portfolio, and the core driver for performance. In the current economic environment, the complexity of managing performance and risk exposure against market volatility make it especially challenging to meet the appropriate liquidity and funding requirements of investment pools.

In lockstep, the ongoing impact of portfolio volatility and the quest to find asset class correlations to hedge are increasing the frequency of asset allocation studies. Typically taking place about once every three to five years to match the longer-term portfolio management horizons, asset allocation is now an annual (or more frequent) event as greater volatility and complexity demand it be reassessed and rebalanced. In fact, 64% of U.S.-based CFA members are making or investigating significant changes to their asset allocations, consistent with 68% of global members.1

Key to measuring compliance against asset allocation of an investment plan is granular insight into the appropriate allocation across all plan investments with a consistent taxonomy. A portfolio analytics and reporting solution can help asset allocators to implement asset allocation more effectively by gaining much-needed transparency in an investment structure that mirrors the asset allocation guidelines for an investment pool. Every investment plan is unique; therefore, it is important to be able to construct the investment pool in a seamless way to measure the macro- and micro-level impacts of all major asset classes and sub-asset classes.

The Art and Science of Asset Allocation

Implementing an investment structure based on an asset allocation study is both a science and an art. It relies on all available asset class data based on ex-post or ex-ante performance, risk, and the correlation between all major asset classes and sub-asset classes. The science is determining the appropriate beta exposures as the asset allocator’s first step in the investment structure design. The art is the asset allocator applying years of experience to determine how best to allocate assets across investments to generate alpha. However, measuring the efficacy of asset allocation is not possible without granular visibility and transparency across the investment structure.

An analytics tool helps asset allocators to bring the art and science together to implement the investment structure and, ultimately, to manage it against investment goals while gaining transparency through portfolio metrics. A tool helps determine whether asset allocation decisions are working by measuring performance and impacts of over- and under-allocation on portfolios, and it offers alternative scenarios to the asset allocation mix.

This is the true value of transparency and insight within the investment pool – both in terms of the investment structure set by asset allocation and in the efficiency gained from a structured process for performance analysis and attribution.

Gaining Transparency from Structure

A disciplined approach to setting up an investment structure is crucial for providing the transparency asset allocators need to implement asset allocations and portfolios more effectively and to determine exposure to certain asset classes, sub-asset classes, and individual securities to maximize performance while minimizing risk. An analytics tool is the best means to implement best practices for setting up investment portfolios at both the macro and micro levels.

At the macro level, the structure is set up to manage the overall portfolio and to identify major asset classes that will ensure target diversification across various beta exposures. Allocations are aligned with the asset owner’s investment policy to ensure compliance as well as manage liquidity to meet short-term and long-term liabilities or spending policy requirements.

At the micro level, underlying investment styles or sub-asset classes are set up within each asset class to appropriately manage risk and return. From there, asset managers are selected to fulfill investment requirements based on investment styles. An analytics tool is crucial for obtaining visibility into each asset manager’s investments and for understanding how each ultimately influences asset allocation and performance of the total investment pool.

An analytics solution that offers flexibility and ease in setting up the investment structure by using best practices across various investment pools is critical to structuring an approach that ultimately delivers the performance details of past asset allocations, which then empowers asset allocators to refine and rebalance future asset allocations for their clients. It can also streamline the analysis of portfolios with different asset allocations and enable asset allocators to accelerate allocation reviews to meet shorter timelines, as well as benchmark allocations against appropriate peers.

Staying Disciplined – and Prepared for the Future

As today’s investors demand faster responses and transparency from their investment advisors, investment structure design and implementation are becoming more crucial to unlocking the value of asset allocation decisions to better manage investments, analyze performance, and attribute performance to underlying success factors.

The right analytics tool can quickly provide asset allocators with the insights and structured approach they need to implement appropriate investment structures according to asset allocations. Asset allocators can drill down to the granular, composite level—such as a major asset class, sub-asset class, style and individual asset manager, or an individual investment – while analyzing performance across active, passive, marketable long-only investments, and alternative investments.

Gaining transparency into the overall performance and attribution of investment asset pools cannot be underestimated in these volatile times. With greater efficiency and analysis at hand, a structured process to implement and manage appropriate beta policy and manager selection will ensure that asset allocators are ready for any future market events or portfolio shocks that come their way.

1 https://www.cfainstitute.org/-/media/documents/survey/cfa-amer-discussion-2020-text-2pp.ashx

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