The asset allocation conundrum

FOR the last six decades, the science of investing embraced Modern Portfolio Theory and the trade-offs for risk-adjusted returns in different asset classes. The theory was that a combination of US stocks and US bonds in a 60/40 proportion amounted to a balanced portfolio. The volatility of stocks was cushioned by traditional bonds in the belief that these two asset classes did not have significant correlation in up and down markets. The Global Financial Crisis changed all that: even quality corporate bonds and some sovereign bonds took a beating in 2008.

For moderate risk/return profile individual investors in Singapore, something similar to the 60/40 rule is being applied by bankers and advisers as part of the mandatory risk assessment prior to the sale of a product. When fixed income assets routinely returned 4 per cent per annum or more, this guideline was totally acceptable because it had a positive contribution to the total portfolio return. With global interest rates presently at very low levels, the signs are there for conservative and moderate risk investors to suffer potential capital losses in the coming years. So what to do?

Where does asset allocation come into play?