Asset Allocation and Investment

Key Concepts

• Asset Allocation: Determining the proportion of each asset class in a portfolio.
• Asset Classes:
  • Stocks
  • Bonds
  • Real Estate Investment Trusts (REITs)
  • Alternatives

Importance of Asset Allocation

• One of the few controllable aspects of investing.
• No optimal asset allocation except in hindsight.

Theories and Models

• CAPM (Capital Asset Pricing Model)

  • Developed by Harry Markowitz, William Sharpe, and John Lintner.
  • Single factor model relating risk and expected returns through market beta.
  • Market beta is a priced risk.

• Market Portfolio

  • A total market index fund represents this.
  • Exposure to global markets (Canadian, US, International Developed, Emerging Markets) is beneficial.

Geographic Asset Allocation

• Canadian Bias:
  • Tax treatment favors Canadian stocks.
  • Canadian stocks often have preferential tax treatment on dividends.

Bonds

• Less risky than stocks, with lower expected returns.
• Canadian bonds have shown high returns due to historically falling interest rates.
• Adding bonds can reduce portfolio risk.

Real Estate Investment Trusts (REITs)

• Adding a 6% allocation can improve returns and reduce risk.

Portfolio Example

• 10% Canadian bonds
• 6% US REITs
• 28% Canadian stocks
• 28% US stocks
• 20% International Developed stocks
• 8% Emerging Markets stocks

Advances in Portfolio Theory

• Fama-French Three-Factor Model (1992)

  • Includes market risk, size, and value as factors.
  • Explains more return differences between portfolios than CAPM.

• Factor Exposure

  • Important for increasing expected returns and decreasing risk.
  • Profitability is another factor recently added.

Challenges

• Obtaining factor exposure can be difficult, especially for DIY investors.

Conclusion

• Total market exposure is critical.
• The mix of stocks and bonds is subjective.
• Factor exposure is beneficial but challenging to implement.

Comments and Feedback

• Viewers are encouraged to discuss their asset allocation strategies.

About the Speaker

• Ben Felix, Associate Portfolio Manager at PWL Capital.
• The video is part of the "Common Sense Investing" series.