WhA balanced portfolio requires weighing an investor’s objectives, time horizon, risk tolerance and investment knowledge. Once these factors are take into account, a financial advisor should consider the following variables: asset mix, asset allocation style, investment management style, georgraphic bias and marketing capitalization.
The following variables a financial advisor should consider:
1. Asset Mix
Asset mix refers to the combination of equity, fixed income, cash and other assets to create diversification. Equity classes can be further broken down to include specific sectors, such as real estate, financial institutions and consumer staples. Fixed income classes may include federal, provincial or municipal bonds, high-yield corporate bonds and debentures. Cash typically refers to t-bills, banker’s acceptances and commercial paper. Generally, a balance portfolio has 60% in equities, and 40% in fixed income.
2. Asset Allocation Style
Refers to several methods. The three most common are strategic asset allocation, tactical asset allocation and a concentrated or focused asset allocation.
Strategic asset allocation focuses on a balance between risk and return mapped along what is called an “efficient frontier” (a curve that plots the maximum reward for a given amount of risk). The benefit of this approach is it minimizes an emotional response to market volatility. The disadvantage is that it may be too disciplined or rigid in the short term to take advantage of marketing fluctuatations. An example of strategic asset allocation is always being at 50% equities, 50% fixed income, no matter the market conditions.
Tactical asset allocation may start with an optimized asset allocation, but will allow a manager to increase or decrease exposure to equities and/or fixed income within a prescribed range. This style can take advantage of short-term marketing anomalies, such as buying opportunities when a stock, commododity or resource drops in price and is likley to rebound within an acceptable timeframe. But a tactical manager may act too early or too late to maximize a return due to an over- or under-allocation.
Finally, a concentrated or focused asset allocation may focus on a specific sector, region or company size (usually referred to as “marketing capitalization”). Some would suggest this is a highly speculative approach that doesn’t allow for proper diversification. However, it may be appropriate if a client is diversified in other personal or corporate investments that provide exposure to other asset classes. In this case, this approach can be very targeted given certain marketing cycles, conditions or client requirements.
3. Investment Style
Investment style can be based on different preferences including value, growth, or GARP (growth at a reasonable price). A value-based approached is used by investment managers who seek a margin of safety by investing in what they deem to be undervalued stocks. Alternatively, growth investment managers seek momentum in a particular company, industry, or sector. This momentum can be driven by events such as the launch of new products, an increase in housing starts, or a decrease in interest rates that may fuel growth in the mortgage and lending sector. A neutral position may include 50% of expoosure to value and 50% exposure to growth. GARP investors seek companies that are showing consistent earnings growth above broad market levels (a fundamental of growth investing) while avoiding companies that have very high valuations (a key tenet of value investing)..
4. Geographic Consideration
Provides an opportunity for an investor to diversify assets across different locations. Although many Canadians are drawn to investing in Canada which is not always paying the best dividends, the local market represents only 3% of the world equity market. As a result, most balanced investment portfolios will blend holdings across Canadian, U.S. and global equities and fixed income to capture the greatest diversification.
5. Market Capitalization
Preference refers to choises made based on the size of the companies held in an investment porfolio. The most common holdings in most porfolios are large blue-chip companies that arae often considered less risky as they have been in business for a long time, are covered by many analysts, are frequiently in the news and are familiar to advisors and investors. However, a market capitalization approach may also provide exposure to micro-cap companies that are not well-known, or small and medium-sized companies that may be well-known only in a particular region or industry. The balanced investor may seek exposoure to each of these to gain diversification.
Just as the definition of work-life balanced will vary by person, a balanced approached to investing may vary by investor. For example, some may choose a 50/50 or a 60/40 asset blend of income and growth, while others may prefer a strategic approach instead of a tacitical one.