What is strategic asset allocation?

• Asset allocation is widely recognised as a key driver of long-term investment outcomes. This means asset allocation is an important decision for investors.

Asset allocation is the process of determining how a portfolio is allocated across different asset classes.This process balances risk and return across a combination of asset classes within a portfolio. Assets can be categorised as growth or defensive. Growth assets are investments that typically carry high levels of risk, but also offer potential for higher returns over time. Whereas, defensive assets generally carry lower levels of risk, and typically lower returns. Equities are an example of a growth asset, whereas fixed income and cash are examples of defensive assets.

Asset classes perform differently in different market cycles; therefore, investors can consider employing a diversified approach in their asset allocation process. A diversified approach combines asset classes where the performance is relatively uncorrelated, so that when one asset class underperforms, the impact may be partially offset by stronger performance from other asset classes.

There are three common approaches to asset allocation:

• Strategic asset allocation (SAA) is constructed on the basis of long-term asset class forecasts, that targets to maintain a set combination of asset classes.
• Dynamic asset allocation (DAA) is an active strategy that adjusts the allocation of assets based on medium term views.
• Tactical asset allocation (TAA) is also an active asset allocation strategy, whereby the allocation is adjusted to take advantage of short-term market opportunities.

Investors should be aware that the more active asset allocation strategies typically incur active fees or higher management costs.

Empirical research shows that SAA accounts for approximately 90% of the variability in portfolio returns over time.¹ This underscores the importance of getting the asset allocation decision right. When selecting an appropriate SAA strategy, investors should consider their time horizon, risk tolerance, and investment objectives. SAA strategies are often labeled to reflect varying levels of risk tolerance—common labels include moderate, balanced, and growth.

The forecasts driving a portfolios asset allocation will evolve over time to align with fundamental, structural and market changes. Therefore, it’s important to continually review and monitor asset allocation forecasts to ensure they align with the risk and return objectives of the SAA strategy. Investment managers may review the SAA annually to reflect long-term capital market assumptions and qualitative insights.

Reflective of asset class forecasts, the portfolio's actual allocations will also fluctuate over time. All else being equal, assets that have performed well will consume a bigger share of that portfolio's value and assets that have done poorly will decrease from their initial asset allocation. Therefore, a strategic portfolio is rebalanced to the annual reconstitution weights on a frequent basis, such as quarterly.