Allocation must be priority for our most valued Assets

Never a week goes by without me seeing and reading blogs and articles on the pro's and con's of active versus passive investment management.

The majority are written by individuals with somethimg to gain by promoting their views from one side of the fence or the other. The fact of the matter is that which is better remains inconclusive.

What I can conclude, however, is that there is a lack of focus and promotion on the need to correctly allocate assets for a client and the overiding importance of this compared to actual fund selection.

It's getting on for 60 years now, since Professor Harry Markowitz published his doctoral thesis “Portfolio Selection”, marking the introduction of what is now known as Modern Portfolio Theory (MPT.

Professor Markowitz established that for any given level of risk, it was possible to construct an investment portfolio that mathematically delivers the maximum possible investment returns. That portfolio is said to sit on the “efficient frontier”.

MPT states any portfolio that does not sit on the efficient frontier is inefficient, as the portfolio is not maximising the returns for that given level of risk.

More recent research by Brinson, Singer and Beebower (Brinson, Singer and Beebower; "Determinants of Portfolio Performance II: An Update"; 1991) indicates that asset allocation is by far the dominant determinant (91.5%) in the variability of returns in a portfolio. Market timing represents 1.8% and Stock Selection 4.6%.

Furthermore, the Myners report of 2001 clearly states the significance of asset allocation and suggested it offers significant long term benefits in preserving and increasing wealth.

The allocation of assets - how much of a portfolio is invested in a given investment sector - drives our risk assessment and investment process, so much so that we have recently added a dedicated page to our website to explain our approach.

So, yes, there is a conversation to be had about passive and active management, but the first priority has to be asset allocation.