A recent report by McKinsey & Company revealed the ways that “leading institutional investors have grown rapidly into significant global organizations” and how these key players are forging ahead. One of the more insightful parts of this McKindsey research is the notion that “until recently strategic asset allocation (SAA) has been rather non-strategic.”
According to the McKinsey report,which is entitled From Big to Great:
“Significant adjustments to the SAA have been rare,with the exception of a long-term trend among many institutions to shift an increasing portion of their portfolios to illiquid assets. Indeed, for most pension and SWF boards, the review of asset allocation decisions has been more or less a rubber-stamping exercise.”
When it comes to strategic asset allocation (SAA), many institutions have foregone the development of an actual strategy. Changes within investing have caused previous methods of the SAA to be ineffective.Largely this lack of efficacy, says the McKinsey report, is due to the fact that “significant adjustments to the SAA have been rare” and the review of asset allocation decisions has been more or less a rubber-stamping exercise.”
Learn how to prevent mistakes with your SAA and how to adopt a better way of investing.
The Problem
In the past, allocations have been based on historical estimates of correlation, returns, and volatility. In general, you were able to look at your SAA from last year as a foundation for your next allocation. But the McKinsey report suggests that using this method has led to institutions not reaping the appropriate rewards for their risks.
How Institutions Are Adapting
Due to these complications, institutions must react and do things differently to achieve long-term returns. Bulking up your portfolio construction team with more people is a great start. The decision-making process surrounding portfolio construction should also be more nuanced and dynamic. Rather than hitting the repeat button on your SAA each year, it should be more of a strategic debate. McKinsey suggests some key goals of constructing portfolios that are taking place within institutions:
- Increasing the likelihood of fulfilling liabilities
- Adopting a clean-sheet approach
- Progressive perspectives on risk factors and assets
- Participatory and rigorous annual decision-making process
The SAA requires more thought, attention, research, and debate than before.