asset allocation

Definition: Asset allocation is the process of deciding how much of a portfolio should be invested in different types of assets.
- Types of Assets:
- Equities (shares)
- Bonds (fixed income)
- Property
- Infrastructure
- Private equity
- Hedge funds
- Cash
Analogy: Think of asset allocation as deciding the recipe for a cake; too much of one ingredient changes the flavor, structure, and outcome of the cake.

For big investors like superannuation funds, insurers, and charities, asset allocation is crucial:
- Primary driver of long-term returns and risk: Asset allocation is far more significant in determining investment outcomes than picking individual stocks.
- Implementation at JANA: JANA spends considerable time designing and recommending Strategic Asset Allocations (SAA).

Different clients at JANA have diverse objectives, necessitating tailored asset allocations:
- Superannuation funds:
- Goals: Long-term growth
- Risk tolerance: Higher risk
- Asset preference: Favors equities, property, infrastructure, private markets
- Time horizon: Decades-long investments
- Insurance companies:
- Obligations: Must meet claims and have stable income
- Regulatory requirements: Must comply with APRA capital rules
- Asset preference: Uses more bonds and less risky assets
- Not-for-profits & endowments:
- Needs: Require stable, sustainable income
- Objective: Must preserve capital
- Risk tolerance: Moderate risk
First job in asset allocation: Understand the client’s objectives.
- Role at JANA: Graduate roles include:
- Preparing reports
- Participating in investment committee discussions
- Proposing asset allocation changes

Strategic Asset Allocation (SAA) – Long-Term Plan
- Definition: The baseline asset mix a client should hold for the next 5 to 10+ years.
- Example of SAA:
  - Equities: 55%
  - Bonds: 25%
  - Property/Infrastructure: 15%
  - Cash: 5%
- Purpose of SAA:
  - Aligns with long-term goals
  - Matches risk/return needs
  - Ensures diversification
- Analogy: SAA is like the "default mode" of a portfolio.
Dynamic/Tactical Asset Allocation (DAA/TAA) – Short-Term Adjustments
- Definition: Adjustments made to a portfolio that temporarily shift away from strategic weights.
- Examples of DAA:
  - If share markets look expensive, reduce equities.
  - If bond yields rise, add more bonds.
  - If inflation rises, increase real assets like property.
- Purpose of DAA: To respond to market conditions in the short-to-medium term.
- Contributions at JANA: Graduates can provide data or insights to discussions regarding DAA.

Equities (Shares):
- Characteristics:
- Higher risk
- Higher long-term returns
- Sensitive to economic cycles
- Diversified globally
- Purpose:
- Used primarily for growth (favored by super funds)
- Not favored by insurers due to volatility.
Bonds (Fixed Income):
- Types: Include government bonds, corporate bonds, and credit.
- Characteristics:
- Lower risk
- Provide income
- Prices typically rise when interest rates fall
- Good for stability
- Usage:
- Used mainly by insurers, not-for-profits, and defensive super options.
Cash:
- Characteristics:
- Safe
- Very low return
- Purpose:
- Used for liquidity.
Property & Infrastructure:
- Characteristics:
- Provide stable income
- Less correlated with shares
- Some inflation protection
- Usage:
- Highly favored by super funds due to long-term stability.
Alternatives / Private Markets:
- Types: Include private equity, hedge funds, and absolute return funds.
- Purpose:
- Used for diversification and return enhancement.
- Reputation of JANA: JANA is well-known for its manager research in these areas.

Volatility:
- Definition: Measures how much returns fluctuate.
  - Equities exhibit high volatility; bonds display low volatility.
Correlation:
- Definition: Describes how assets move relative to each other.
  - High Correlation: Two assets that move up and down together.
  - Low Correlation: Assets that move independently of one another.
  - Negative Correlation: One asset moves up while the other moves down.
- Importance: Diversification relies on low or negative correlation, a principle used by JANA for portfolio construction.
Diversification:
- Analogy: "Don’t put all your eggs in one basket."
- Combining different asset classes reduces risk without significantly diminishing expected returns, a cornerstone of JANA’s consulting philosophy.
Drawdown:
- Definition: The worst significant declines a portfolio experiences.
- Importance for institutional clients:
  - Drawdowns affect member confidence, insurance capital requirements, and charities’ abilities to fund programs.

Understand Client Goals:
- Return target
- Risk tolerance
- Time horizon
- Liquidity needs
- APRA rules (if applicable to insurer or super fund)
Run Modelling:
- Methods Used:
  - Capital market assumptions
  - Stochastic models
  - Historical data
- Outputs:
  - Predicts expected returns, volatility, and correlations.
Test Different Portfolio Mixes:
- Examples:
  - 60/40 vs 70/30 allocations
  - Adding more infrastructure
  - Reducing hedge funds
  - Increasing global equities
- Objective: Experiment with various combinations.
Choose the Strategic Asset Allocation (SAA):
- Select the SAA that most closely aligns with the client’s objectives.
Add Dynamic/Tactical Views When Appropriate:
- Adjust allocations based on JANA’s market predictions, e.g., anticipating equities will outperform or bonds will struggle.
Select Fund Managers:
- After determining the asset allocation, JANA selects specialist managers for each asset class.
Monitor, Report, Adjust:
- Graduate Role Includes:
  - Preparing reports
  - Updating dashboards
  - Reviewing performance
  - Analyzing if the SAA remains valid.

Three Key Takeaways:
1. Strategic Asset Allocation: Represents the long-term mix that drives returns.
2. Asset Classes: Behave differently under various market conditions.
3. Risk Management: Achieved through diversification and correlation, forming the foundation of investment consulting.