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Whose Job Is Asset Allocation?


Asset allocation is diversification across asset classes, geographies, currencies and sectors. It is critically important to all investors both Institutional and Individual. Given that, who is responsible for this decision – Manager, Investor or Advisor?

Is the Investment Manager responsible?

Should (when?) things go wrong, investor (and advisor) tendency might be to blame the investment manager. In the case of a mutual fund manager, say, their job is to manage to the objective of the fund. Indeed, a mutual fund manager will not likely ever meet the Individual investor and will have no regard for the investor’s requirements. The investment manager (in this case) is not in a position to add asset allocation value. This is likely the case for an Individual investor. For the Institutional investor it’s likely the same. (Unless the Institution has a single manager hired for asset allocation. Further, a ‘balanced fund’ manager would have asset allocation responsibility).

Is the Investor responsible?

Charlie Ellis writes in “Winning the Losers Game”, that ‘investors often delegate – even abdicate – responsibility for asset allocation’. Ellis suggests that the investor has the responsibility of articulating requirements and preferences such that an appropriate asset allocation policy (that is consistent with their objectives) can be formulated. It’s a valid point. Too many investors expect plans to be prepared FOR them. But many Individual investors aren’t equipped to provide asset allocation input. (‘I like returns and don’t like risk’ isn’t enough direction). All investors have an obligation to provide CEO-like guidance as to investment policies but, without expert knowledge, the average investor cannot reasonably be expected to make the asset allocation decision alone. Institutions rely on some form of modeling (usually by an outside consultant) to ensure there is a reasonable basis for the asset mix decision.

Is the Advisor responsible?

Whoever profiles the Individual investor must assume responsibility for translating investor requirements and guiding the investor toward an appropriate asset mix policy. This must be the advisor. Indeed, investor expectation of advisor expertise is implicit. (Isn’t this the purpose of profiling or know-your-client in the first place … to arrive at a mix that will achieve the investor’s objectives but is within their constraints? Isn’t this ‘profile’ how Institutional investors come up with a ‘job description’ for their individual investment managers)?

Problems can arise, however, when the advisor and client influence each other. Investors (of all kinds) sometimes want returns with no view to risk. Advisors (of all kinds) sometimes sell individual products with no view to the investor’s overall portfolio (and, by definition, their asset allocation).

Either way, product-based decisions may not work out. (This is true not just of investment related decisions). How often does the investor expect historical investment returns as advertised? Can the investor ‘buy’ historical returns? No. But an advisor can ‘sell’ historical returns.

Can an advisor try to lower client expectations … without being fired? (GMO’s Jeremy Grantham calls this career risk. Others have called this the paradox of responsibility. Doing the right thing might cost an advisor the client).

For Individual investors, one answer might be ‘asset class portfolios’ or ‘pies’ that provide an asset allocation choice with slightly different asset mixes. With the asset allocation decision made, the decision becomes which pie best suits investor requirements and is still within their tolerances. Are you Conservative? Moderate? Or Growth oriented? Keep it simple.

If Advisors only sold asset class portfolios and if Individual inventors only bought asset allocation pies, both would be better off. Investors would at least be somewhat balanced and the impact from the advisor and investor influencing each other is at least be moderated.

Next time?

Why 60/40?

Doug Cronk, CFA is Manager, Investments for a Canadian Pension fund.

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