Category: Asset Allocation

Asset allocation is incredibly important. Fans of the Efficient Market Hypothesis and Modern Portfolio Theory think that it’s responsible for most of the risks and rewards of your portfolio, and I’m inclined to agree.

But just because it’s important doesn’t mean it’s going to take ages to do or require a rocket scientist to help out.

You might think that five minutes to make your asset allocation decisions is not enough, but I’m going to cheat and give you five different ways to set your asset allocation in just one minute each.

I’m sure you don’t need me to tell you what mood the market’s in.  Borderline panic is probably as good a description as any.  I may not like the panic, but as a value investor I do like the bargains it throws up and one such bargain may well be the FTSE 100 itself.

The FTSE 100 closed last Friday at 5,129, about 13% down from when the carnage began in early August.  At that level, it has a PE10 of about 12 (PE10 is the 10-year average real price-to-earnings ratio) while the PE10 average is around 17.6. PE10 has been a pretty good indicator of future returns over the last century and it’s a favourite of mine for checking what sort of returns might be possible in the next few years.

This is just a minor update to my previous post about allocating assets to stocks depending on the current value of CAPE compared to its long-term average.  In the graph using Shiller data I plotted a straight line at 16.35, the current long-term average of CAPE. 

However, it would perhaps have been better to show the CAPE average as it would have looked at the time, therefore removing the benefit of hindsight and showing what information investors would have had at the time.  And here it is, with the long-term CAPE average shown in black:

I’ve mentioned my tactical asset allocation efforts in a couple of previous posts.  Both of those have been somewhat vague about how I actually decide on the stock/bond split, although not deliberately so. 

If Ben Graham can shout out the Net Net method to the world over 50 years ago and not have its effectiveness affected, then surely my tiny whispers on the web can do my approach no harm. 

In fact, it may to some miniscule degree make the markets more efficient.  Like the proverbial fly stopping an oncoming supertanker.  Perhaps I may even win a Nobel Prize, but I doubt it.

As mentioned previously, my wife’s pension is invested using a ‘tactical asset allocation’ function dreamed up by my good self.  It basically uses the long-term average of the FTSE’s real CAPE (real as in adjusted by RPIX).  More specifically it uses the long-term average of what I call CAPE10, which is the average of the last 10 years CAPE values.

I’ve long been fiddling around with various mechanical methods of adjusting an almost passive index investing strategy to improve the risk/reward ratio.  This is sometimes known as Tactical Asset Allocation (TAA).  I thought I’d put up some charts of my efforts.

I’m a big fan of CAPE (cyclically adjusted price-earnings) and Tobin’s Q as tools for understanding expected future risk and returns from a stock market.  After reading Wall Street Revalued: Imperfect Markets and Inept Central Bankers, I’m an even bigger fan.