What Is Asset Allocation?
When building a portfolio the selection of the right mutual funds is essential, but so is making sure that we have the right asset allocation. Here at CH, each mutual fund is selected based on how it fits within one or more of the following asset classes:
- Canadian Fixed Income
- International Fixed Income
- Real Estate Income
- Alternative Strategy
- Large Cap Canadian Equity
- Large Cap International Equity
- Small Cap Equity
The asset classes are ranked from top-to-bottom as least risky to most risky (in other words, least volatile to most volatile). Asset allocation is a very important dynamic process in the creation, rebalancing, and asset shifting in an investor’s portfolio. An investor’s asset mix should be reflective of an investor’s goals and their tolerance to risk. So how will a client’s asset mix change and why?
Creating a portfolio
When an investor becomes a client at CH Financial, our wealth advisors first have a conversation to gain an understanding of the client’s goals and their risk tolerance. Understanding this is fundamental in classifying what portfolio is suitable for a client. CH offers three different types of portfolios: conservative, moderate, and aggressive. Each of these portfolios has its own suggested asset allocation weightings. For example, a moderate portfolio will have a suggested Large Cap International Equity percentage that is different than a conservative portfolio. Once our wealth advisor determines which portfolio is suitable for the client, they construct the client’s portfolio using mutual funds that we offer in each asset class. Each client portfolio is customized based on the different accounts the client has or requires, how to best optimize their tax situation, and what their financial goals are.
Rebalancing of a portfolio
Proper diversification limits a client’s portfolio concentration, meaning that it spreads out risk. The idea is that even if one part of a portfolio is performing poorly, other parts of it will be doing well, and the net effect is a better overall rate of return with lower total risk.
So where does rebalancing fit into all of this? A diversified portfolio will have some parts (asset classes) that will perform better than others at any given time and as they do so, will increase their total weighting in the client’s portfolio. For example, if the global equity market (e.g. Large Cap International Equity) is performing well and the Canadian bond market (e.g. Canadian Fixed Income) isn’t, the client’s percentage in Canadian Fixed Income will decrease while the percentage of Large Cap International Equity will increase. In this example, the asset allocations are naturally changing due to assets in the Large Cap International Equity asset class growing in value faster than those mutual funds in the Canadian Fixed Income asset class. This prompts a rebalancing to bring the asset class back within the suggested allocation range.
Making shifts between asset classes
Unlike our previous example where rebalancing is a result of different asset classes performing better or worse over time, making shifts between different asset classes is the result of a conviction. Just as portfolio managers of our mutual funds actively manage the securities within their mutual funds, our wealth advisors at CH actively manage which mutual funds should be held in each client’s portfolio. Our Investment Review Committee (IRC) meets regularly to review CH’s portfolio as a whole, and during these meetings we will use our views and convictions regarding the economy, market sectors, stocks, bonds, and the prospects for different countries to make decisions on possible changes. These decisions may then impact the suggested weightings for all three types of our portfolios (conservative, moderate, and aggressive).
For example, if we believed that there will be a pullback in the real estate market, we may reduce this asset class weighting for our Real Estate Income Trusts and alternative strategies. During our next set of meetings with our clients, we would then recommend to trim this asset class accordingly.
The asset allocation of a client’s portfolio will never look the same as when it was first created. Naturally, asset classes grow at different rates and will need to be re-balanced, while shifts will be made as the world changes and CH responds to those changes. The mutual funds an investor holds are important, but we at CH believe that getting the client’s portfolio optimized with asset allocation is just as important. If you’d like to discuss your portfolio and its asset allocation, your wealth advisor would be happy to do so.
As always, we welcome any questions or comments.
All the best,
Devin Gorgchuck, Financial Advisor
& Your CH Financial Team