Asset Allocation Bulletin
The asset allocation process is one of the foundational elements of portfolio construction. In its simplest form, it considers an investor’s return goals and how much risk the investor is willing to take. It uses this risk and return profile to determine an optimal portfolio mix between asset classes, such as higher risk/higher return equities and lower risk/lower return fixed income. The result is an “efficient” pairing of risk and return. This means an investor is minimizing the amount of risk taken to achieve a return target, or maximizing the amount of return received given a tolerable amount of risk. This highlights the two approaches to the asset allocation process: return targeting and risk (also called volatility) targeting. Though it may seem like a nuance on the surface, there is a substantial difference between these two approaches, and adopting one or the other can have a significant impact on both the long-term returns and experienced volatility in a portfolio.