Asset allocation is the fundamental tool for building portfolios that meet the risk/return goals of each client. Asset allocation ordinarily enables achieving targeted returns with less risk. Because 90%+ of portfolio performance is attributable to asset allocation Benchmark works diligently to construct client-specific and effective asset allocation.
Benchmark relies heavily on customized asset allocation programs designed to meet the risk/reward profile of each client. Many asset managers use historical return, risk and correlation data from “backward looking” external vendors as the foundation for their asset allocation decisions. What is unique about Benchmark is not only the use of their own “top-down” and “bottom-up” research and analysis but, more importantly, the fact that they use this information to derive proprietary forward looking return expectations. This proactive approach, based on detailed fundamental analysis, creates much different outcomes when markets are at extremes. For example, the chart below illustrate Benchmark’s expectations and our view of the overvaluation of stocks in 2005 and relative attractiveness in 2009 when values returned to mean, long-term values.
The forward-looking nature of our research is illustrated by the above chart. Benchmark, using Benjamin Graham’s ten five-year earnings smoothing as the basis for its PE (price earnings ratio) and data from Robert Schiller, viewed the market as expensive (see chart #2 below). PE’s calculated this way were above 20x in 2005, near the peaks from previous cycles. In other words, expensive. Employing a mean reversion long term outlook, Benchmark determined that there was little payoff for taking risk in that environment. Equities are preferred when using Graham-style PE’s are well below (or at least near) long-term mean values. Simply put, markets with PE’s below the historical median produce larger returns over the long haul
The net result of our forward looking asset allocation (mean reversion based) has been that our portfolios have been very different than the consensus. Our clients have benefited because of this approach. Looking forward, when the Graham-style PE move decisively below its long-term mean we will add equities to our portfolios as return expectations change. In addition, while this example highlights the Benchmark approach to equity asset allocation, the same fundamental and disciplined approach to analysis is applied to other asset classes as well.
