blog29jul2007

Hot Off the Web
This week’s Hot Off the Web is heavily focused on asset allocation.
The Financial Times’ “How to allocate your assets” readers are reminded that asset allocation is still the dominant contributor to long term returns. The only significant changes that have occurred since 2000 are pertaining to: (1) more sophistication in calculating forward looking assumptions, (2) main asset classes have expanded from cash, equity and fixed income, to also include alternative investments, commodities and property with a foreign exchange overlay strategy (all but the forex overlay strategy is fairly simple to implement with currently available ETF/ETNs). Hedge funds and private equity are also used in the asset allocation as these are good diversifiers; however these asset classes require much more expertise in selection as there is huge performance variation between top and bottom quartile funds.
Still on the topic of asset allocation, Richard Croft in Financial Post’s “Don’t take risk unless you must” says that real estate( your house that you are living in) should be included in one’s overall portfolio if they plan to sell it in order to pay for retirement; one’s defined benefit pension plan should also be included as part of the overall asset allocation. On the subject of risk he expresses the opinion that “investors should build a more aggressive asset mix because they need to, not because they can”! Sounds like wise advice.
Still continuing on asset allocation, in “I can ‘decumulate’ with the best of them”  the Financial Post’s William Hanley discusses David Cork’s warning that retirement you must be able to simultaneously manage investment and longevity risk (you have read about this here at the Life-Cycle Investing ); the challenge is how decumulate one’s assets to simultaneously meet both near-term cash flow need and longer term needs (as well as satisfying the desire to live an estate for many). He quotes the following statistic from Don Ezra: “for the average pension holder planning to retire at age 65, and expected to live to 85, 20% of post-retirement income comes from contributions, 40% comes from growth of capital during pre-retirement years and 40% comes after retirement”. I.e. asset mix after retirement is still key component for success. The suggested solution is a “cash flow liability matching” scheme. He suggests a four tiered asset allocation: (1) years 1-2 cash, (2) years 3-5 laddered maturity of government bonds, (3) years 6-10 a 60:40 stock: bond mix, and (4) years 10+ a more aggressive 75:25 stock: bond asset mix. Sounds like a workable approach that would not be difficult to set up and maintain.
We talked previously about the extreme care that you must take with Life Settlements; in “Profiting from mortality”  this week’s BusinessWeek’s cover story discusses not only the risk for those wanting to sell their existing (or even not yet existing) life insurance policy, but also cover the risk (and potential returns) associated with bonds sold to investors, that are packages of these life settlements. No doubt we’ll be hearing more of this in the future as the baby boomer generation retires and many may no longer have need of their in force life insurance policies and may wish to capitalize on them at a better rate than the insurance company may be offering.
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