Determining Your Sub-Asset Allocation

The investment landscape is vast and complex with thousands of options for investing in stocks, bonds, mutual funds and more. Building an appropriate portfolio to meet your long-term investment goals can be a complicated task. Fisher Investments employs a top-down investing process (Exhibit 1) to help identify appropriate investments for our clients. Top-down investing begins by looking at the big picture—economic analysis, political trends and sentiment drivers. It is based on the philosophy that longer-term returns are most significantly impacted by higher-level decisions such as asset allocation (mix of stocks, bonds, cash and other securities) and category choices (sector, country, and other specific decisions). After making these higher-level decisions, we select individual securities for your investment portfolio. This article will primarily focus on the second portion of our top-down process—sub-asset allocation.

Exhibit 1: Top-Down Investing Process

Subcategories of Different Investment Asset Classes

We believe that asset allocation accounts for approximately 70% of a portfolio’s return over an investor’s time horizon. Asset allocation selection can include selecting from asset classes such as stocks, bonds, mutual funds, real estate and commodities, cash and more.

Although we believe asset allocation accounts for the majority of long-term portfolio returns, sub-asset selection also plays an important role. In our experience, sub-asset selection can contribute to approximately 20% of a portfolio’s return. This selection involves analysis and decisions within an asset class, and these decisions vary based on the characteristics of each asset class.

Here we will outline a few of the options to choose from within some common asset classes.

Types of Equity Sub-Asset Allocation

If the environment looks favorable for owning equities (stocks), which kind should an investor invest in? We break down our equity sub-asset allocations in different ways including, but not limited to, the following:

• Country/geographic region: If global economic factors favor certain regional markets, you may consider overweighting your portfolio towards those areas you think will perform well.  
• Sector: Different sectors of the market—such as Energy, Industrials or Financials—may perform differently in various market conditions or stages of the market cycle. Consider these differences when deciding the appropriate allocation of funds to different sectors.
• Capitalization: Your choice of stocks from large-cap, mid-cap or small-cap companies may change based on your forecast on the current market cycle.
• Valuation: Should you own value or growth stocks? Both offer high quality companies, and differentiating between the two can be difficult. Growth stocks tend to have higher valuations and grow faster than the overall economy. Value stocks, on the other hand, tend to have lower valuations, often pay dividends, and might have lower price-to-earnings ratios.  

Fixed-Income Sub-Asset Allocation

If you are interested in fixed-income securities or bonds, you will have to decide which bonds to hold in your portfolio: government, corporate or municipal bonds. Fixed-income investments have their share of risks, complexities and unique characteristics. Important considerations for allocation of fixed-income assets include, but are not limited to:    

• Duration: This is a measure of bond price volatility. Bonds of longer duration tend to be more sensitive to interest rate changes.[i]
• Issuer type: Bond issuers can include corporations, municipalities, governments or government agencies. Each carries different risk and return characteristics. For example, US Treasuries may not be volatile, but their yields can be lower. High-yield bonds, on the other hand, may carry higher interest rates and greater volatility.
• Credit quality: When considering bonds, keep in mind the risk that the issuer could default. For this reason, researching the entities whose bonds you buy can be an important step.   
• Taxable status: Different types of bonds are taxed differently. For example, US Treasury interest is only taxable at the federal level, whereas interest from corporate bonds is normally taxable at the federal, state and local government levels.
• Liquidity: Selling bonds is not necessarily as quick or easy as selling most stocks. Some bonds are not very liquid, and if an investor needs to sell one in a hurry, they may have to sell at a discount.

Portfolio Diversification

Portfolio diversification is an important part of investing for retirement. Market conditions are in constant flux, and investments may move in and out of favor. Large or small companies may lead at different times. Sector leadership also rotates, as does leadership across geographic regions. No investment style or category is superior for all time. It is important to maintain appropriate diversification across asset classes and categories to capture the benefits of the market cycles.

Investors with less money to invest may be able to diversify using pooled-asset products, such as mutual funds or exchange traded funds. These vehicles can provide broad exposure to various countries, sectors and more. However, high net worth individuals may benefit more from the flexibility and personalization of investing in individual positions when diversifying.

Our active top-down investment approach helps us respond to market developments for our clients. However, no money manager is correct every time, including Fisher Investments. But the lessons we have learned from managing investments through several market cycles can help give us valuable insight into constructing client portfolios for the future.

Learn More About Fisher Investments Today   

A trusted financial adviser can help with allocation of asset classes and strategies for subcategory investing. Having an adviser who can focus on research into category leadership over the course of market cycles can help you achieve your longer-term financial goals. To learn more about Fisher Investments, call us at 1 (888) 823-9566 or download one of our educational investing guides today.