Fundamental rules Because of the fundamental nature of assets over time, in the presence of inflationary risk and the absence of risk aversion, for a given liability profile over time there is an optimal allocation to cash, fixed interest and equities. The basic structural rules for the management of assets within a liability management framework are therefore as follows. Outside of risk aversion and excess valuation risk, the only rationale for lower risk assets is to provide short term security of capital and income needed to meet liabilities in the event of significant short term stock market and economic risk. In the absence of liabilities equities are the most efficient long term asset class. The amount of low risk assets held within a portfolio is directly related to the amount of liabilities a client has arising over the designated period of ”significant short term stock market and economic risk”, or the short term continuum . Longer term assets (equities) are held within the time frame over which they are most efficient, while low risk short term assets are allocated to where they are most efficient. The allocation at the margin is managed in accordance with fundamental management of excess risk and return.
The structure provides a defensive box in which income and capital security can be maintained while the management of excess risk and return can be used to enhance return and risk management over time at the margin within a time frame which does not expose the portfolio or liabilities to excessive risk.
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