In this week’s video insight, I dive into the topic of asset allocation and how to approach balancing risk and return. Using the analogy of a boat, I explain how equities can act as the engine driving growth, while credit serves as the hull that keeps you steady. The right strategy depends on your stage of life and financial goals. I also touch on the growing appeal of private credit for its potential to deliver strong returns with less volatility. The ultimate goal is to build a portfolio that’s built to last through all conditions.

Transcript:

Hi, I’m Roger Montgomery, and welcome to this week’s video insight, where we endeavour to help you become a smart investor. 

To me, our industry is thrilling and important. To many others, including my own adult kids, it’s about as boring as anything can be. I must confess, the topic I’ve selected to speak to you about today, even I think sounds boring. That topic is asset allocation. How do you decide how much to invest in each asset class? How do most people think about the decision? And what’s a helpful way to construct a portfolio or at least a helpful framework to have in the back of one’s mind when making investment decisions?

Professional investors and their advisers have a variety of considerations when thinking about asset allocation. They might be deciding between how much to invest in equities and how much in debt? Or more conventionally, how much in stocks and bonds, and how much in ‘alternatives’? To help with that decision, they may also think about how much in to have in public securities, and how much in private assets, and many investors are seeing the merit of a higher allocation to private assets.

Then there’s the decision about how much to place in local equities, and how much overseas. Once you’re overseas, how much should you invest in developed markets and how much in emerging markets? There’s clearly a bunch of ways to cut the cake.

All the while professional investors are applying asset allocation models that themselves are based on expected returns, risk, and correlations, most of which is based on history rather than the future. It can be a case of precision being precisely wrong.

I think there’s a simpler idea that forms the beginnings of a framework for asset allocation. It’s all about risk and your appetite for it… Instead of risk being the product of the portfolio construction process, the desired risk level is targeted and securities then selected to meet that risk objective.

So think about this, think about your portfolio as a boat. The boat will keep you safe, if not always completely dry, amid the storms that inevitably strike as it sails you through life.

To begin, you will need a hull to keep you afloat. You will also need an engine to keep you moving ahead (sorry yachties, we aren’t going to let ourselves be blown around by the wind)… and the engine keeps you facing the right way when it gets rough)… and finally, for some, the engine my have a little turbo attached to it, given the engine a bit more of a kick when conditions are right.

Now, to build this boat, there’s only really two asset classes that matter; there’s equity, and there’s debt (or, as I prefer… credit).

Depending on your age and your wealth the shape of the boat and its size will vary, but all investors will have some allocation to each (by the way, that equity can be public or private). Perhaps, if you are younger, you can have a bigger engine and a smaller hull. As you mature, you might be happier to move forward at a more leisurely pace because you are enjoying the slower journey offered by a smaller outboard engine and a bugger and safer hull.

It’s worth remembering that equities are further right on the risk spectrum; they offer a much wider band of potential returns from very high to very low but over the very long run, and provided your fund manager has selected the right companies, that volatility of returns will produce an outcome that should have you keeping up, with, or outpacing inflation.

Of course, these days, private credit offers the potential for equity market-like returns without any of the volatility of public markets. If you can get circa 10 per cent per annum annual returns – which is even better than long run stock market returns – without any of the volatility associated with the stock market, you might consider private credit for the hull of your asset ‘boat’.

Private credit offers a narrower band of returns but also, provided the credit ratings are high, the expected outcome can be positive each year, indeed for some funds the track record has been positive every month.

The idea is to combine the right blend of private credit and equities (be those, public or private) that gives you a boat you are happy to stay in for a long time, and an engine that provides a tolerable combination of expected down side with the promise of inflation-beating returns.

From that point, you can think about the right equity exposure, whether that’s public or private, large or small, domestic or international, developed or emerging. And while you are thinking about those things rebalancing based on annual weighting targets or tactical decisions, your hull is keeping you happily afloat come what may.

Well, that’s all we have time for today. I hope you enjoyed the insights that we’ve provided, and I look forward to talking with you again soon. In the meantime, please continue to follow us on Facebook and X, and please like and subscribe.