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Investment view – Brian Tora

Getting the asset allocation right is far more important to investment performance than stockpicking.

I recently attended a presentation by the head of research at Barclays Investment Services, Gary Dugan. To a group of portfolio managers, he gave a thought-provoking and controversial message. Trying to guess which Footsie stock will outperform was, in his opinion, a waste of time. What really counted was getting the asset allocation right.

Backed up by a welter of statistics, he mentioned that 91 per cent of the source of outperformance of a benchmark or peer group came from the asset-allocation decision. Only 5 per cent was delivered from stock selection – hence his call to stop trying to pick winners in a narrowly defined market. Even market timing delivered minimal benefit. According to a study published in the Financial Analyst journal, just 2 per cent of the portfolio outperformance arose as a result of this particular endeavour.

The study that Dugan drew on as evidence was published in the 1990s but the lessons seem just as true today. Most UK managers of private investor portfolios spend most of their time picking leading UK shares or trying to make the call between holding equities or bonds. Choosing whether to be more global in investment spread, or favouring smaller firms over bigger ones would be a better way to spend their energy, if the conclusions of Messrs Brinson, Singers and Beebower – study authors – are to be believed.

Examining a wealth of data, Dugan arrived at what he termed Charts of Exploitable Opportunity. Even among dedicated investment managers, charged with looking after a defined pool of assets, outperforming the benchmark was very much the exception than the rule.

The reality is that this world of investment management has become more professional and competitive over time. A positive cornucopia of funds exists to provide access to a wide range of specific markets. With evidence suggesting that most fail to beat the benchmark – the UK’s headline index – the case for some measure of indexation appears strong. There should be no surprise in that. Indices do not suffer costs in the way that a managed portfolio does. Whatever way you look at it, management fees and transaction commission are a tax upon performance. But managers have to live, so the costs of running an investment fund will continue to present potential problems. How much you pay, though, is a matter of choice. Using one of the cheaper tracking options, such as an exchange traded fund, will clearly deliver cost advantages.

Of course, good performance is always worth paying for. Unfortunately, you only know if your money has been wisely spent after the event. Past performance is usually taken by the end investor as a guide on what to expect but it is by no means reliable. Little wonder regulators consider what has been achieved before should not be taken as any real measure of future performance.

This whole business of how best to construct a portfolio and what tools to use to make the decisions lies at the core of the business. Understanding the dynamics of individual asset classes has become much more important. Those running portfolios for private investors need to be able to justify their actions. How the assets you choose to meet specific needs might behave is worth a further visit in this column.

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