What is Asset Allocation?
As its name suggests, asset allocation is the collective percentage of investable capital ‘allocated’ to each ‘asset’ class. The conventional ‘60/40’ stock and bond portfolio showcases a traditional asset allocation model. Namely, 60% of investable capital is allocated to stocks while the remaining 40% of investable capital is allocated to bonds (see chart).
Traditional asset classes fall into two broad categories: equities (stocks) and non-equities (bonds and cash). Alternative investments represent a non-traditional category in modern portfolios. These broad asset classes consist of multiple ‘sub’ asset classes (see chart). For example, large-capitalization U.S. equities and international equities are sub asset classes within the broad equity asset class. U.S. Treasury notes and investment grade bonds are sub asset classes within the broad non-equity asset class. Managed futures and long/short strategies are sub asset classes within the broad alternative asset class.
The Importance of Asset Allocation
Asset allocation is the most predominant component of portfolio performance. Studies have shown that asset allocation accounts for approximately 86% of portfolio returns.1 In short, the percentage of assets allocated to equities vs. non-equities is the principal determinant of portfolio performance over time.
1Brinson, Beebower, Hood. Determinants of Portfolio Performance. 1986