The long climb toward investment success may require consistent effort, but also flexibility to avoid obstacles and stay on track.
Asset allocation is probably the most important element in determining the potential success of an investment portfolio, but it may also be the hardest to adhere to in a rigorous way. Conceptually, investors are generally familiar with the idea that investments should be diversified across asset classes to spread risk. They may also have a vague notion about the behavioral differences among stocks, bonds and other categories that can offer insulation when one asset class is doing worse than another. However, beyond these general contours, the process of developing and maintaining an asset allocation is less understood, which we think is unfortunate because in our view effectively seeking the ultimate success of that asset allocation is reliant on the details—fashioning a portfolio structure consistent with individual goals, and following through to ensure that remains the case.
In our opinion, while an effective asset allocation is always important, this may be especially true in times of market difficulty, when that structure can help anchor investors to what they are trying to achieve over the long term, and limit the temptation to make abrupt changes that could undermine those goals. In a sense, the process of creating and maintaining an asset allocation is a bit like taking a long mountain climb, across a range of topographies and weather systems. Obstacles may emerge—storms, wild animals, rockslides—but the ability to course-correct and still maintain progress is what ultimately could make the difference. In this article, we review some key elements of the journey that asset allocation represents, and share our ideas on best practices.
Climbing the Asset Allocation ‘Mountain’
Source: Neuberger Berman. For illustrative purposes only.
Asset Allocation Has Largely Driven Portfolio Returns
Source: Vanguard, 2021. Calculations were based on monthly returns for 709 American funds from January 1990 to September 2015. Calculations were based on monthly net returns, and policy allocations were derived from a fund’s actual performance compared with a benchmark using returns-based style analysis (as developed by William F. Sharpe) on a 36-month rolling basis. Funds were selected from Morningstar’s Multi-Sector Balanced category. Only funds with at least 48 months of return history were considered in the analysis. The policy portfolio was assumed to have a U.S. expense ratio of 1.5 basis points per month (18 bps annually, or 0.18%). For illustrative purposes only. Nothing herein constitutes a prediction or projection of future events or future market behavior. Due to a variety of factors, actual events or market behavior may differ significantly from any views expressed or any historical results. Indices are unmanaged and not available for direct investment. Investing entails risks, including possible loss of principal. Past performance is no guarantee of future results.
Create Your Investor Profile
There are no shortcuts to developing and maintaining a portfolio customized to fit unique personal goals. It generally requires considerable reflection and work with advisors.
Typically, the process begins with a focus on the investor, to develop a clear sense of available assets and the various necessities and aspirations that they anticipate in the future. We also want an idea of the investor’s risk capacity (the amount of risk they need and are able to take in pursuit of goals) and, a more psychological measure, their risk tolerance (or the risk they are willing to take in order to help meet those goals). The latter is often based on personality, values or general attitude toward risk.
Which Portfolio Would You Prefer?
Source: Neuberger Berman. For illustrative purposes only.
Depending on the existing asset level, investment timeframe and long-term “capital market assumptions” (return outlooks), the investor’s goals may prove to be very achievable, within range or unrealistic. However, even if achievable, they may not be appropriate if the investor cannot tolerate the corresponding risk exposure and is likely to want to sell at a poor time. A clear mountain pass may provide opportunity to save time, but may be the wrong choice if danger signals may cause the walker to retreat or progress too slowly.
Develop a Strategic Asset Allocation
With the investor’s goals in mind, we can estimate a target rate of return that can help achieve them, and then see, based on our firm’s capital market assumptions, a hypothetical of what this might look like in terms of associated portfolio risk and asset mix. Thinking about the mountain hike, your strategic asset allocation is like a trail map with your route and destination clearly marked.
Naturally, there are always tradeoffs. Equities generally carry extensive risk of near-term volatility. Bonds can balance risk, but typically offer less total return potential. Private equity or debt may offer a premium to public markets, but that comes with illiquidity risk. Cash may also have tactical use, and save assets in the near term, but when held over time tends to lose ground to inflation.
After some back and forth with an advisor, the investor can often settle on an asset allocation that occupies a middle ground—seeking to provide a combination of return potential and the ability to mitigate dangers that jibes with the investor’s unique makeup.
In light of the potential risk-mitigation benefits of diversification, the allocation may include core equity and bond holdings, diversifying assets within both areas, such as small-cap and international equities, or high yield bonds or preferred securities, and some exposure where appropriate to alternative assets such as private equity or hedged strategies. These “diversifiers” can play a valuable role in reducing volatility, enhancing yield, growing assets and/or reducing correlations across the portfolio. From there, the asset allocation can be implemented with specific investment strategies and managers potentially well suited to each category.
Deviations Through ‘Tactical Tilts’
Although the overall direction of the portfolio may be determined by your “map,” the details and specific route may vary, depending upon what is encountered along the way. Where feasible, shorter-term tactical “tilts” from your strategic allocation may be appropriate to, for example, help minimize the impact of market volatility or capitalize on lower valuations in particular asset classes. In other words, you may have more than a few opportunities to reshape your portfolio in light of changing circumstances.
In the current environment, we believe that investors should generally try to limit overall sensitivity to equity market risk, which may involve emphasizing securities that tend to be relatively insulated from broad economic and market fluctuations, and more dependent on individual business dynamics. Writ large, this may mean favoring value over growth shares, and looking to equity income given the relative durability of dividend payouts that it could provide. Taking inflation into account may also be important, by looking to fixed income with less sensitivity to interest rate risk, and assets that may be more correlated to higher prices, such as real estate and commodities. Finally, exposure to private markets may offer differentiated return opportunities that are less sensitive to short-term market disruption.
Overall, your ultimate goal of reaching the summit remains the same. However, the route you take to navigate past unexpected obstacles may be adjusted to reach the top safely and efficiently.
Market Volatility Has Intensified
S&P 500: Trading days > 1% move
Source: Bloomberg, as of August 31, 2022. For illustrative purposes only. Nothing herein constitutes a prediction or projection of future events or future market behavior. Due to a variety of factors, actual events or market behavior may differ significantly from any views expressed or any historical results. Indices are unmanaged and not available for direct investment. Investing entails risks, including possible loss of principal. Past performance is no guarantee of future results.
Investment Themes for Volatile Times
Implementing Your Allocation
Although we believe asset allocation is the cornerstone of an effective portfolio, populating that allocation with appropriate strategies is also crucial. Here at NB Private Wealth, the Investment Strategy Group (ISG) leverages broad expertise to help develop investment solutions for U.S.-based private wealth clients. ISG works closely with wealth advisors, portfolio managers and clients with the goal of designing and implementing customized and diversified investment plans. By tapping into the extensive investment capabilities across the firm, including capital markets assumptions, asset allocation and Environmental, Social and Governance disciplines, ISG incorporates our best thinking across both public and private markets to construct tax-efficient, multi-asset class portfolios.
Monitor and Adjust
A key, in our view, is to revisit your overall investment framework on a regular basis in light of your goals. Wealth planning is not a static process, but a dynamic one. Market conditions may change, and so may your priorities, lifestyle or family circumstances, including unforeseen health events or the need for long-term care. If, based on a periodic review, you appear to be running behind where you should be, that may require shifts in allocation, or perhaps more focus (for those still in the earning years) on saving. On the other hand, if you find that you have more than you may need, you can take the opportunity to dial back on risk exposures.
It is crucial that adjustments to portfolios take place in a measured, incremental way that takes into account market realities, but keeps in mind long-term trends. Investors have often panicked in very difficult periods, pulling back on market exposures at the wrong time—and essentially stopping progress completely. This can be detrimental, as market recoveries often take place in short spurts, often when investor pessimism is at its worst. The fallout from such “untimely” market timing is evident from looking at a hypothetical portfolio that has missed strong days in the market.
Sticking to an Asset Allocation Is Important
Missing Best Days Has Hurt Performance: Hypothetical Growth of $10 Million Over the Last 10 Years
Source: Bloomberg as of June 30, 2022. IMPORTANT: The performance and risk projections/estimates are hypothetical in nature and are based on the assumptions set forth herein. The estimates do not reflect actual investment results and are not guarantees of future results. Results are gross of fees and do not reflect the fees and expenses associated with managing a portfolio. If such fees and expenses were reflected, results shown would be lower. Investing entails risks, including possible loss of principal. Past performance is no guarantee of future results.
Keeping on the Path
In the end, we believe your asset allocation should be a reflection of you and what you wish to achieve in life. One of the ways that investment goals and allocations can go wrong is when a person deviates from long-term strategy, whether taking on too much risk in a strong environment or “turning back” at an inopportune point in a market decline. We believe the current environment is testing the resolve of many investors; and given concerns about economic and market dynamics, it is likely an appropriate time to reassess exposures and the immediate path forward. What can make that analysis more meaningful is a true understanding of your goals and destination, and where your portfolio is on the “map” in relation to achieving them. Such knowledge can help you make intelligent decisions to press forward and have more confidence in difficult times on your financial journey.
IMPORTANT: The projections and other information generated by a Monte Carlo analysis tool regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results and are not guarantees of future results. A Monte Carlo analysis runs multiple simulations of your wealth analysis against future market conditions. The result of introducing random investment volatility to the analysis produces a range of values that demonstrates how changing investment markets may impact your wealth. Tools such as the Monte Carlo analysis will yield different results depending on the variables inputted and the assumptions underlying the calculation.
Hypothetical scenarios shown are for informational and educational purposes only. Examples are based in part on various assumptions, projections or other information generated by Neuberger Berman regarding investment outcomes. Growth rate assumptions and projections are hypothetical in nature, and do not reflect actual investment results and are not guarantees of future results. Calculations are based upon Neuberger Berman’s Investment Strategy Group’s capital market assumptions. Assumptions are updated periodically. Changes in assumptions would impact the hypothetical results shown. Estimated returns and volatility should not be used, or relied upon, to make investment decisions. Actual results may vary significantly and actual growth rate may be higher or lower, including negative growth (i.e., investments lose value), than any hypothetical scenarios shown.
This material is provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This material is general in nature and is not directed to any category of investors and should not be regarded as individualized, a recommendation, investment advice or a suggestion to engage in or refrain from any investment-related course of action. Investment decisions and the appropriateness of this material should be made based on an investor’s individual objectives and circumstances and in consultation with his or her advisors. This material is not intended as a formal research report and should not be relied upon as a basis for making an investment decision. The firm, its employees and advisory clients may hold positions within sectors discussed, including any companies specifically identified. Specific securities identified and described do not represent all of the securities purchased, sold or recommended for advisory clients. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. Neuberger Berman, as well as its employees, does not provide tax or legal advice. You should consult your accountant, tax adviser and/or attorney for advice concerning your particular circumstances. Information is obtained from sources deemed reliable, but there is no representation or warranty as to its accuracy, completeness or reliability. All information is current as of the date of this material and is subject to change without notice. Any views or opinions expressed may not reflect those of the firm as a whole. Any discussion of environmental, social and governance (ESG) factor and ratings are for informational purposes only and should not be relied upon as a basis for making an investment decision. ESG factors are one of many factors that may be considered when making investment decisions. Third-party economic or market estimates discussed herein may or may not be realized and no opinion or representation is being given regarding such estimates. Neuberger Berman products and services may not be available in all jurisdictions or to all client types. The use of tools cannot guarantee performance. Diversification does not guarantee profit or protect against loss in declining markets. As with any investment, there is the possibility of profit as well as the risk of loss. Investing entails risks, including possible loss of principal. Investments in hedge funds and private equity are speculative and involve a higher degree of risk than more traditional investments. Investments in hedge funds and private equity are intended for sophisticated investors only. Unless otherwise indicated, returns reflect reinvestment of dividends and distributions. Indexes are unmanaged and are not available for direct investment. Past performance is no guarantee of future results.
The views expressed herein may include those of the Neuberger Berman Multi-Asset Class (MAC) team, Neuberger Berman’s Asset Allocation Committee and Neuberger Berman’s Investment Strategy Group (ISG). The Asset Allocation Committee is comprised of professionals across multiple disciplines, including equity and fixed income strategists and portfolio managers. The Asset Allocation Committee reviews and sets long-term asset allocation models, establishes preferred near-term tactical asset class allocations and, upon request, reviews asset allocations for large, diversified mandates. Tactical asset allocation views are based on a hypothetical reference portfolio. ISG analyzes market and economic indicators to develop asset allocation strategies. ISG consists of five investment professionals and works in partnership with the Office of the CIO. ISG also consults regularly with portfolio managers and investment officers across the firm. The views of the MAC team, the Asset Allocation Committee and ISG may not reflect the views of the firm as a whole, and Neuberger Berman advisers and portfolio managers may take contrary positions to the views of the MAC team, the Asset Allocation Committee and ISG. The MAC team, the Asset Allocation Committee and ISG views do not constitute a prediction or projection of future events or future market behavior. This material may include estimates, outlooks, projections and other “forward-looking statements.” Due to a variety of factors, actual events or market behavior may differ significantly from any views expressed or any historical results. Nothing herein constitutes a prediction or projection of future events or future market or economic behavior. The duration and characteristics of past market/economic cycles and market behavior, including length and recovery time of past recessions and market downturns, is no indication of the duration and characteristics of any current or future market/economic cycles or behavior.
A bond’s value may fluctuate based on interest rates, market conditions, credit quality and other factors. You may have a gain or loss if you sell your bonds prior to maturity. Of course, bonds are subject to the credit risk of the issuer. Neither Neuberger Berman, nor its employees provide tax or legal advice. You should consult your accountant, tax adviser and/or attorney for advice concerning your particular circumstances. This information should not be construed as specific tax or investment advice. Please contact a tax advisor regarding the suitability of tax-exempt investments in your portfolio. If sold prior to maturity, municipal securities are subject to gains/losses based on the level of interest rates, market conditions and the credit quality of the issuer. Income may be subject to the alternative minimum tax (AMT) and/or state and local taxes based on the investor’s state of residence.
Neuberger Berman Investment Advisers LLC is a registered investment adviser. The “Neuberger Berman” name and logo are registered service marks of Neuberger Berman Group LLC.