Multi-Asset Portfolio Management:
More than the Sum of the Parts
by Nathaniel Riley, CFA, Senior Strategist
June 28, 2021
Managing a multi-asset portfolio means more than just holding a diversified basket of various asset classes. Or at least it should.
To maximize a portfolio’s potential, at Boston Trust Walden we seek to understand how the individual asset classes are managed and how they fit together. But this can be difficult to accomplish if we don’t embrace the full complexity of the task at hand.
In this post, we explain how our high quality investing style can inform not only stock selection but also asset allocation and bond portfolio composition.
Narrow Framing Bias
When faced with a complex problem, the first inclination is often to break it down into smaller, simpler parts. In the language of behavioral finance, this is known as “narrow framing”—a decision-making bias that shifts focus away from the big picture toward simpler, more straightforward choices.
Narrow framing is a useful heuristic for many small decisions we make each day, but when the task at hand is complex and the components are interrelated, such a process can result in an outcome that is far from optimal. For example, if I am at a restaurant and make all decisions piecemeal, I may end up with French onion soup as an appetizer, followed by porterhouse steak, a side of mac and cheese, and cheesecake for dessert. While I might enjoy these foods individually, they are uniformly rich, and the meal would be so filling I couldn’t possibly finish it. If instead I thought about the bigger picture when ordering, and how the dishes would go together as a whole, I would likely have a more satisfying dinner.
Unfortunately, at many investment firms, multi-asset portfolios are constructed piecemeal, and the results are not always satisfying. One investment team may manage equities, another bonds, and yet another may oversee the portfolio’s asset allocation. In such a siloed approach, each decision along the way is conducted independently, with limited consideration of how portfolio positioning in one area should affect positioning in the others.
An Integrated Approach
At Boston Trust Walden, we have been managing multi-asset portfolios for over 45 years using an integrated approach rather than a siloed one. We recognize that when managing multi-asset portfolios, how one asset class is managed can alter how the entire portfolio is structured. Below, we focus on one example: how an equity investing style focused on high quality companies can affect not only which stocks are held, but also the optimal asset allocation and the composition of a bond portfolio in a multi-asset strategy.
Boston Trust Walden’s equity investing style focuses on high quality companies that are more profitable and stable than peers. A diversified portfolio of high quality equities typically exhibits lower volatility over time than a comparable index. When constructing a multi-asset portfolio, lower expected volatility of a given asset implies a higher optimal weight for that asset, so using high quality equities implies a higher weighting in stocks.1 For portfolios managed relative to a multi-asset benchmark, this also means that a higher-than-benchmark weight can be held in stocks while maintaining benchmark-like risk. This is beneficial in all circumstances, but especially when the difference in expected returns between stocks and bonds is large.
Adjusting for a particular equity style does not necessarily end with a decision to alter the asset allocation; we also consider the composition of the fixed income investments since different types of bonds have different relationships with stocks. Returns on corporate bonds, for example, have historically been positively correlated with stocks. This has been particularly true during times of economic stress when credit spreads widen, often leading corporate bonds to decline in value along with stocks. If equity allocation rises due to a lower volatility equity investment style, the positive correlation between stocks and corporate bonds may generally result in a lower optimal corporate bond allocation. In place of corporate bonds, a higher allocation to US Treasury bonds may be preferred because Treasuries often display negative correlation with equities in an adverse economic scenario.2
The example above shows how a long-term stylistic investing choice in one area can affect the structure of a multi-asset portfolio. But the concept extends to many other circumstances, since any change, including short-term tactical positioning, must be evaluated in the context of the total portfolio.
Succumbing to the bias of narrow framing and managing portfolio components in isolation means a portfolio manager could miss opportunities to optimize performance of the whole portfolio. At Boston Trust Walden, we aim to improve outcomes for our clients by managing multi-asset portfolios using a disciplined and holistic approach.
1Reducing volatility of an asset will increase an asset’s optimal portfolio weight when using mean-variance optimization or similar portfolio construction methods, assuming the asset’s expected return and correlations with other assets remain unchanged when volatility is reduced.
2It is entirely possible that the optimal allocation to stocks and corporate bonds could both be higher (or lower) than the benchmark allocation under certain circumstances. For example, if strong corporate profit growth is expected in the forecast horizon, leading to a tactical view of higher equity valuations and lower corporate credit spreads, the result may be higher expected returns and higher optimal portfolio weights in both assets despite their positive correlation.
Past performance is not indicative of future results. Boston Trust Walden does not guarantee any minimum level of investment performance. There is a potential for loss in any investment, including loss of principal invested. The information provided is for education purposes only and is not investment advice or an offer of investment services. The information provided is not a solicitation to buy or sell any security, product, service or fund. Prior to making any investment you should always consult with the appropriate legal, tax, or financial professional.
About Boston Trust Walden Company
We are an independent, employee-owned firm providing investment management services to institutional investors and private wealth clients.