The Key to Asset Allocation: It’s All in the Mix

It’s the end of June, halftime on Wall Street, midpoint of another up-and-down year for investors.

For asset allocators such as David A. Hammer, it’s also a good time to plot strategy for the months ahead. Hammer, head of Curbstone Investment Management in Sandy, Utah, reevaluates his clients’ portfolios at least once a quarter, each time rejuggling the mixture of the stock, bond and cash investments held.

He strives to come up with an optimal mix of these asset classes, rather than worry about buying the most promising securities within each category. “Various studies have shown that from 80% to 96% of a diversified portfolio’s performance comes from its asset allocation vis-a-vis its individual securities selection,” Hammer says.

With asset allocation, the intent is to determine which investment categories or markets have the best potential at the moment. Allocators periodically switch their weightings as the outlooks for the various asset classes change. All strive to find a magical mix of stocks, bonds and cash--and perhaps other types of portfolio stuffers such as international equities and precious metals. In a sense, the approach is like balanced investing, but with more shuffling among asset types.

Asset allocation gained some credibility in the October, 1987, stock market crash, when equities fell across the board while bonds rallied and money market products held steady.

But even during less turbulent periods, one asset category usually does better than others. “Over the past 15 years, either stocks have beaten bonds or bonds have beaten stocks by an average of 6% per calendar quarter,” Hammer says. That’s why allocators insist that if you can get the asset mix down, you’ve got the hard part behind you.

Asset allocation strategies work well with mutual funds. Because funds are diversified, they will usually mirror their categories much more closely than a single stock or bond could. In addition, most fund families allow telephone switching, making it possible for you to change your allocation instantly, usually at little or no cost.

Although asset allocators share an interest in finding that optimal mixture, no two use the same formula. The tough part is interpreting the many economic, monetary, market sentiment and other factors that come into play--and translating it all into an approach that works.

Hammer, for example, analyzes interest rates, investor confidence and other factors to come up with an expected return for stocks, bonds and cash. He believes that the stock market is now overvalued, and he recommends just a 24% weighting in equities for someone with a five-year horizon, compared to 66% in bonds (or bond funds) and 11% in money market instruments.

Investors with a longer-term outlook could afford to maintain a higher equity weighting. That’s because stocks tend to outperform bonds 60% of the time and cash 80% of the time, says Hammer, who explains his approach in a new book, “Dynamic Asset Allocation” ($49.95, John Wiley & Sons).

But others look at the financial tea leaves and come up with different conclusions and weightings. Tom Gunderson, portfolio manager of the MIMLIC Asset Allocation Fund in St. Paul, Minn., is more optimistic for the stock market. He’s got the MIMLIC portfolio most heavily invested in equities (56%), followed by bonds (41%) and cash (3%).

Like Hammer, Gunderson estimates future returns for the three key asset classes, and he compares recent performance numbers to historic levels. Interest rates and investor confidence figure prominently in Gunderson’s analysis--and to this he adds “subjective” observations on the economy, politics and the international scene. Because 1992 is a presidential election year, he believes that the White House and Federal Reserve will stimulate the economy to appease voters and that that could lead to higher stock prices.

Gunderson’s asset mix is in line with the allocation recommended by the research staff at Shearson Lehman Bros. The brokerage’s model portfolio is 60% invested in equities, 35% in bonds and 5% in money market instruments.

But Shearson regards such broad weightings as merely a starting point. To help investors fine-tune their allocations, the company recently unveiled a new computer program that takes personal circumstances into account. With the help of a broker, investors input such variables as age, risk tolerance, years until retirement, inflation expectations and yearly income and expenses. The program produces a recommended asset mix.

“The program doesn’t tell you what to invest in, but it gives a breakdown based on where our investment strategists and economists think you should be,” says Kenneth H. South, a Shearson second vice president in Costa Mesa. Like other allocators, Shearson’s researchers estimate relative risks and returns for the various asset classes, South says.

Although asset allocation approaches clearly vary, many place a high priority on reducing risk. This is evident from the fact that most hold at least some fixed-income investments at all times. “We’re conservative players, not home-run hitters,” Gunderson says. The objective isn’t to beat the Standard & Poor’s 500 each year, he says, but to participate in rising stock markets while protecting capital.

The Right Combination

Rather than juggle your equity, bond and money market holdings, you can have an asset allocation mutual fund do it for you. These generally conservative portfolios don’t always keep up with the benchmark Standard & Poor’s 500. But many do a good job of avoiding losses--a key point if you think the stock market is overvalued. Here’s a look at some of the group’s better performers.

Total Return Fund 1987 1988 1989 1990 1991* Sales Fee AMEV Advantage Asset Alloc. -- -- +23% -1% +10% 4.5% (800) 800-2638 Dreyfus Capital Value +35% +8% +25% +1% +2% 4.5% (800) 645-6561 Fidelity Asset Manager -- -- +16% +5% +14% None (800) 544-8888 MIMLIC Asset Allocation +4% +10% +19% +3% +11% 5% (800) 443-3677 Prudential FlexiFund Strategy -- +11% +20% +1% +11% 5% (800) 225-1852 Vanguard Asset Allocation -- -- +24% +1% +9% None (800) 662-7447 Standard & Poor’s 500 +5% +17% +32% -3% +12% --

* 1991 performance through June 24.

Performance source: Morningstar Inc.