What is the single most important determinant of success in investment? Stockpicking? Forget it. Choosing the right fund manager? Close but no cigar. No, the most important factor in any investment decision is asset allocation.
Readers of this newspaper will be only too familiar with the business of assessing how much of a portfolio should go into equities, how much into bonds and how those investments should be spread around the globe and across industrial sectors.
Alas, if only the public were so wise. JP Morgan Fleming, one of our biggest fund management groups, polled the man on the street and the woman on the Clapham omnibus about asset allocation. Shock, horror, nearly three out of four people had no idea what it was talking about.
More than half of those surveyed – this is where I sound like the host of Family Fortunes — said they had no idea what the term meant. Almost one in 10 thought it referred to the practice of borrowing money to spread risk (an interesting if somewhat confused notion) while 6 per cent thought it was a tax-planning wheeze involving the gifting of possessions to another. Yet the top prize surely goes to the bright sparks – yes, more than one person had this daft notion – who defined asset allocation as “a fitness term referring to the distribution of muscle around the body”. They need to spend less time at gym and more time looking at their personal finances.
While the poll identified a profound ignorance of asset allocation among the public, it is fair to say that even the professionals apply the practice in differing ways. For some, it is distribution of equity investment by geography. For others, it is the division of a portfolio by industrial sector. For the rest, it is the mix of cash, fixed income, property and equities in a portfolio.
Choosing the right asset class is by far the most important job, whether the goal is to lessen risk through diversification or to maximise returns. Anyone who sold all their shares and banked the cash in early 2000 would obviously have every reason to feel smug. But how much better off they would have been if they switched the money into Government bonds.
Geographical allocation is probably the least profitable venture, largely because the world has shrunk. The concentration of equity in fewer and fewer companies means that stockmarket indices are increasingly driven by just a handful of international companies. With an pan-global outlook, they are exposed to the same economic weather.
In the UK, the seven biggest companies by market capitalisation – BP, HSBC, Vodafone, GlaxoSmithKline, Royal Bank of Scotland, AstraZeneca and Shell – account for nearly 40 per cent of the total London market. An investment in a UK fund is largely an investment in oil, pharmaceuticals, telecommunications and banking. All of them are international businesses.
So, as Ken Fisher, the US investor, is keen to point out, major stockmarkets around the world behave much like each other. Run price performance graphs for the world, the US, the UK, France, Germany and so on and you will see that they are all the same shape – boom, bust and gradual recovery. Choosing by geography makes a difference to returns only at the margin.
With the annual return from equities forecast to be in single digits for the next five years, a bit of scrapping over the few extra percentage points might seem worthwhile to those interested in relative performance but the traditional method of asset allocation – 50 per cent in the UK, 20 per cent in the US, a similar chunk in Europe and the rest in the Far East – must be nearing obsolescence.
Individual fund managers, with a few exceptions such as Hugh Hendry at Odey Asset Management, no longer carry out asset allocation, believing their job is to do what it says on the fund's tin. If it is a mainstream European equities fund, that is what they manage, even if they cannot make money in the sector over the short term. The ball is in the IFA's court. Hand on heart, how many of you can recall the last time a client asked about asset allocation? No wonder distribution funds are expected to be flavour of choice during this Isa season.
Richard Miles is investment editor at The Times