"Assetallocation" has become the “modus operandi” of a large swathe of the financial services industry. Unfortunately, on its own, it is not an investment discipline.

What does asset allocation mean?

Asset allocation basically means where you are invested; how much in cash, how much in fixed interest, how much in equities; how much in larger, smaller, medium sized companies, how much abroad, how much in different sectors etc, etc. 

It also means where you allocate your assets, irrespective of the reason and irrespective of the method. 

Just why "asset allocation" is banded about as some form miracle cure is down to various quotes drawn from an "important study" into the return on US pension funds carried out by Gary Brinson and others in 1986 and 1991.  

These quotes actually misrepresent the study.  If you are interested in finding out why, please see the following link;

 http://publish.uwo.ca/~jnuttall/asset.html#S11. 

The quotes taken from these studies attest that on average some 90% (the figure does vary according to each quotation) of returns can be accounted for by asset allocation.  Only some 10%, apparently, of return is due to stock selection and getting the timing of your purchases and sales right.

Another key reason for “allocation’s” rise to prominence has also been the supposed “inability of most portfolio managers to consistently out perform the index”.  This is discussed in investment discipline under attack

The "Asset Allocation" study suggests that if you were to invest in the stock market and spend time selecting shares, most of the return that you could get from the shares you selected you could get by just investing in the market index.  This is much simpler and much cheaper.

But, "asset allocation" does not solve the problem of how do you determine where you should invest, how much should you invest and how do you manage it once it is invested.  Most importantly of all, it does not solve the problem of how financial needs relate to the asset allocation process.

  There are therefore a number of problems with the simple version of asset allocation.

While asset allocation principles have much to recommend them, it is the way in which asset allocation is being used in the financial services market place that is a cause for concern.

Companies without investment discipline and without valuation, portfolio construction and management expertise are able to deliver portfolios to their clients while extolling the virtues of diversification and the benefits of asset allocation, benefits which cannot truly be delivered without the ability to manage risk and return.

Mean Variance Optimisers as asset allocators

One easy way of delivering portfolios to the retail client has been the use of mean variance optimisers.  These are the portfolio construction and management tools that a lot of the industry uses.

Why these portfolio solutions are delivered to the individual investor is discussed in the Portfolio Problem, one of the topics listed in the Basics of Investment. 

While they provide a risk and return rationale for asset allocation and in this context solve a lot of the problems of the simple asset allocation arguments, they do not relate asset allocation or its management to either financial needs or the current risk and return opportunities in the market place.