Peter Bickley: Asset allocation plans are dead; long live asset allocation plans

be wise to close your ears, eyes, mouth (and nose) until he has gone away (hopefully soon).

But asset allocation itself can sometimes be harder to get a grip on than blancmange. Following all professionals’ mantra – “why keep it simple when with a bit of effort it can be really complicated?” – asset allocators do like to dress it up. Is this merely to make themselves feel good or is there a purpose?

You can, of course, keep it very simple. Young people with something to spare may be happy with risk assets and will ride out stock market cycles. The more elderly may feel driven towards the security of bonds.

Those for whom a shred of system is a comfort might adopt the actuarial shorthand that bonds as a percentage of a portfolio should equal your age. During the balmy days when stock markets went up and bonds yielded something that might have been okay, the amazing run in gilts would have put a spring in any pensioner’s step. But like most neat and elegant solutions, this one can be lethal; that implied asset allocation (60 per cent bonds for a 60-year old) could now be catastrophic.

Traditional, so-called “top down” asset allocation – the process that was familiar through much of my career as a strategist – has long enjoyed the attractions of logic. It is transparent and it makes intuitive and rational sense.

Resting on an informed view of the macro-economic outlook (thus performing the laudable service of giving employment to economists), the asset allocation would balance the prospective returns from different asset classes against their measured riskiness.

Following examination of an investor’s attitudes to risk and return – during which all parties did, of course, fully understand what they were talking about – a perfect match could be created.

There was a time when the asset class universe was somewhat binary – equities or bonds. Never cash; give an investor any cash and he’d go and spend it, with deleterious effects on your assets under management.

This used to feel quite smart enough until institutions like Yale University came to demonstrate that more imaginative allocations could transform the results.

By investing across a range of types of assets, many of which would have been considered fit only for the mildly unhinged, we could harness varying correlations to manage the riskiness of portfolios to a whole new level of sophistication. Thus was born the so-called “multi-asset class’ method of asset allocation, a method that, I have to say, I embraced with some enthusiasm.

This did raise the game in many ways and asset allocation had finally become really complex, involving magical black boxes (nifty spreadsheets actually) and made us all look rather clever.

However, it was vulnerable on several levels. The dependence on forecasts was all well and good when the world was a fairly predictable place but it became a fatal weakness when wheels started coming off. And all that carefully crafted risk management built around long-observed patterns of correlation proved worse than useless when the patterns suddenly changed, as in 2008 for example. By then, too, the linkage between the macro-economic analysis and asset allocation choices had broken down; analysis might, say, point to the UK as an attractive bet but if you then went off and bought the FTSE you would be 70 per cent exposed to non-UK earnings.

So, all that lovely complexity was an expensive sham, perhaps? Maybe, but probably not. The seductive appeal of those spreadsheets did – and still does – lull some into false certainty but that does not negate the need for hard work.

The reality is that we have to be even more sophisticated. Asset classes are not neatly definable as they once were and, in these economically stressed times, pricing and valuations are often irrational, throwing the usual assumptions even further out of the window.

Recent years have been unkind to asset allocation; the answer isn’t to ditch it, just do it better.

• Peter Bickley is a consultant economist