It is a little known fact that 90% of investment performance
depends on asset allocation. For example, if you have the
very best stock market adviser, one who helps you outperform
other investors in the stock market, it is of little use if
the whole of the stock market crashes as it does from time
to time. Similarly, if you put all your money into investment
properties you could be in dire straits if the rental market
collapsed and houses became unsellable, a scenario that also
occurs periodically.
What were the traditional asset classes?
If we take one’s personal residence out of the equation
there were traditionally just three main asset classes for
people to invest in, namely cash, bonds and equities. Up to
a few years ago this is where insurance companies, pension
funds and individuals would invest their money. A pension
fund might hold for example 60% in stocks, 30% in bonds and
10% in cash. This way of thinking got a rude awakening in
the first three years of the millennium. The bursting of the
technology bubble and the three year long bear market seriously
depleted the reserves of insurance companies, pension funds
and many individuals. Some reacted by drastically reducing
their equity holdings and replacing them with bonds. Insurance
companies and pension funds were faced with a serious dilemma.
If they stayed with stocks and the market kept falling, their
capital would be seriously at risk. On the other hand, if
they moved out of stocks completely it would take decades
to recover losses because they would not benefit from any
recovery in the market. In fact, the world’s stock markets
recovered strongly in 2004 so those who gritted their teeth
and hung in recouped most of their losses. Many individual
investors cut their losses and invested in real estate, helping
to fuel an unprecedented property boom in many parts of the
world. Those who moved in early will have done well but anyone
moving in more recently is at risk from the inevitable bust
that always follows a boom. Many refuse to believe that this
will happen but history is not on their side! As with all
success stories, those who boldly move in early reap the greatest
rewards but the masses who tend to move in once the trend
has been long established invariably end up with burnt fingers!
So what is the answer?
Experts can give us a good idea as to in which direction assets
are likely to move. But they are not always right and timing
is extremely difficult. Many wise heads have got together
to resolve this dilemma and the answer they have come up with
is to develop model portfolios. They can be tailored to a
person’s base currency and risk tolerance, both of which
must be carefully determined. The models are considered strategic
in that they represent a long term strategy. They avoid the
temptation to invest in the ‘flavour of the day’
such as gold in the 70’s or technology stocks in the
late 90’s. They have been ‘back-tested’
to produce reasonably accurate projections of future performance.
For example, a balanced portfolio should generate a return
of 6% to 8% on average allowing for a possible losing year
of 1 in 5 (compensated for by higher returns in other years).
The models are not completely inflexible. There is still room
for a large investor to make some ‘tactical’ investments
with proper financial advice outside the model, but the model
should still act as a core investment.
A typical model
The following is an example of a balanced model portfolio
for a USD investor (it would be broadly similar in GBP, Euro
or AUD). The actual percentages may change from year to year
after review by asset allocation experts.
Cash (deposits etc.): 8%
Domestic bonds: 22%
International bonds: 3%
Alternative fixed income: 12%
Domestic equities: 16%
International equities: 10%
Fund of hedge funds: 16%
Commercial property: 13%
____
100%
Since the above assets must be allocated to individual funds
it is not possible to achieve the ideal spread with less than
US$100,000 due to fund minimums, but an attempt can be made
to get smaller investments as close as possible to the models.
Any particular implications for expats in Bali?
Not really, as the same principles apply to investors worldwide.
There may be a greater likelihood however that long term expats
in Bali have significant local assets such as a house, business
etc. They need to bear in mind that such assets do not have
the same degree of security or liquidity as an offshore portfolio
that enjoys legal protection in secure jurisdictions and which
is accessible at any time anywhere in the world. It may not
produce a return comparable to a successful business in Bali
but its function is one of capital protection and steady,
albeit modest growth.
Colin Bloodworth is a senior adviser with Financial Partners
International. The views expressed are his own. If you have
any questions you may contact him at 021 520 8099 or
colin.bloodworth@financial-partners.biz
