Several statistical studies have found that the price behavior of securities, such as stocks, options, and commodities, is indistinguishable from that of random numbers and constitutes a “random walk.” Over many decades, the prices of all investments trend upward due to inflation and economic growth. Nevertheless, this is of little help since most investors don’t have unlimited time to build their net worth. Moreover, a given class of investments can trend downward for a decade or more or stall in price for two decades.

 

 

FACTORS THAT INFLUENCE INVESTMENT PRICES ARE RANDOM AND UNPREDICTABLE. Economic, political, technological, cultural, and other factors, which affect investment markets, are unpredictable. For example, repeated studies have failed to find that economists can predict such simple variables as interest rates, inflation, or G.D.P. growth with any accuracy six months in advance. Financial experts routinely fail to predict big market shifts and are continuously surprised by this or that unexpectedly strong or weak economic statistic, earnings report, or sales figure. Further, investment experts rarely have unanimous agreement on anything and frequently hold strikingly contrary opinions on the future. The future is, quite simply, unpredictable.

 

RISK AND RETURN ARE ABSOLUTELY CORRELATED. High potential returns always involve high potential risks. There are no low-risk/high-return investments. Investment risk comes in many forms but, to most investors, risk means the potential for losing investment capital and the duration or permanency of that loss. Through analyzing the best available long-term data, researchers have carefully defined the risk/return ratios of all major asset classes and identified the correlation or interdependence of different types of investments. These findings provide our best approximation of future risk and return for any given asset class or mix of asset classes.

 

 

ASSET CLASS IS, BY FAR, THE MOST IMPORTANT DETERMINANT OF INVESTMENT RETURNS. An asset class is a group of securities, which have similar risk and return characteristics. One-year Treasury bonds, or commercial real estate, or small company U.S. stocks, or emerging market stocks are examples of asset classes. Research has clearly established that performance differences between different professional money managers are due predominately to the asset class they choose. Market timing and securities selection and trading, very popular investment strategies; add almost nothing to investment returns.

 

DIVERSIFYING ASSET CLASSES OPTIMIZES RISK AND RETURN. Through computer analysis, possible combinations of portfolios can be created and probable risks and returns clearly defined. An optimal mix of asset classes depends upon many factors including an investor’s age, time frame, net worth, tax bracket, and risk tolerance. Using research generated from Modern Portfolio Theory, the long-term risks and returns of various portfolios can be precisely defined and tailored to the individual investor.

 

PORTFOLIO FUNDING IS THE NEXT STEP.  Once the ASSET ALLOCATION decision has been determined, the MONEY MANAGERS can be selected for each asset class. The use of mutual funds provide the best opportunity to select managers due to the broad selection of funds available for each asset class and the ability to measure fund performance relative to their peers. In some cases INDEX funds provide superior results, in other instances, professionally managed funds offer better results, depending on the asset class.

 

For any investor, it is important to develop a solid investment strategy to achieve their long-term goals. One way an investor can do this is by comparing their current portfolio to a portfolio with an ideal asset allocation. This introduction is meant to show you the benefits of using asset allocation in a portfolio.

 

An asset allocation strategy takes into account the historical performance of stocks, bonds, and cash and exploits their different return characteristics to improve the probability of achieving a desired long-term total return. Stocks, bonds, and cash do not always gain or lose value at the same time, so setbacks in one category can be offset by gains in another. Historically, volatility has been reduced over time by holding all three-asset classes in a portfolio.

It is important to note that asset allocation is not the same as diversification, which allows an investor to spread risk within a single asset class. Though diversification is also an important tool in the toolbox of investing, relying on it alone causes an investor to ignore other asset classes that could help them achieve their long-term goals. For example, many people invest with mutual funds and say, “I am diversified. I invested in three different mutual funds.” While in reality, if we look closely at the mutual funds that investor holds, we may discover that all three of those funds are Large Growth Funds and those funds own many overlapping securities. This investor is not invested in any other asset classes such as Large Cap Value, Small Cap Equities, International Equities or Fixed Income. They are spreading their risk in just a small section of the overall market.

 

Asset allocation differs from simple diversification because it involves being diversified in more than one asset class—not only in mutual funds, such as large cap growth and value, but also, for example, in fixed income, whether it be a federal or a corporate issue. Diversification within an asset class is important, but it is equally important to spread risk among various asset classes. Asset allocation benefits an investor by reducing the volatility in their portfolio while also attempting to maximize their portfolio return within the limits of their accepted level of risk.

Investors must realize that investment returns vary from a short to a long time frame. They must also understand the risk in their investment choices and set realistic expectations for the growth of their assets. By applying the concept of asset allocation to a portfolio, an investor will reduce portfolio volatility by spreading risk over various asset classes. Asset allocation also structures an investor’s assets to help them achieve their goals with a minimum level of risk. This should give investors confidence that their money will grow over time at an expected level and be there when they plan on needing it.

 

 

The firm of Michael Phillips Black Wealth Management believes that in the post 2008 “Great Recession” era, financial management has been expanded beyond Modern Portfolio Theory, or, now, “Post” Modern Portfolio Theory. Since the advent of MPT the world economies have globalized, or become intermingled. The historical relationships between asset classes have changed over time, causing the historical benefits of MPT to be diminished. In other words, the predictable benefit of diversification: while one asset class that is “Zagging”, another is “Zigging” is less beneficial today than it was historically. For instance, US and Foreign stocks today tend to move together.

 

In today’s markets, investment management has been forced to focus on a more Global Tactical style. This involves investing globally: based on the economic “drivers” that may be causing a particular country’s economy, and therefore, markets moving forward/up. The first step is to identify where the economies/drivers are growing and what parts (sectors) of those economies are driving the growth. 

 

The tactical aspect of this style is to determine the pricing of these growing economies/sectors. Markets become overvalued as investors take advantage of these economic drivers and market improvements. Even though a particular Country/Market/Sector presents growth opportunities, it may be overpriced, and not appealing at that price. But, as markets, correct, opportunities arise, and a tactical manager takes advantage of those opportunities…….assuming the economic drivers still exist. 

 

In today’s investment environment, one must be observant of Governmental policies that affect the economic drivers, credit cycles and Geo-Political events. All these processes require Global Tactical portfolio managers to be very nimble and proactive to markets, moving monies to the most opportunistic places and ready to sell when markets become overvalued and buy when they become undervalued, all based on the fundamentals of the economic drivers.