How does one classify a balanced portfolio

wanna_make_some_dough

Hello All,
What should be the ideal distribution of stock sectors (cyclical/sensitive and defensive) in a balanced portfolio?  
What is considered the ideal distribution of investment style size -- large, mid and small cap? And styles value, growth and blend?

Or are these wrong attributes to base a balanced portfolio?

Thanks for your help

ColdIron

You asked this 3 years ago

wanna_make_some_dough said:

What is considered a good weighting on market cap? (large cap/med cap/small cap) What would you consider a good split sector wise?

What does ideal mean to you?
What are you trying to achieve?

What is the ideal distribution of clothes or the contents of your fridge?

JohnWinder

Those different segments of the market have taken turns in giving better returns, so if you can guess when large cap will outperform the others the preferred ‘balance’ would be all large cap. S&P estimates, pretty roughly, that the professionals get that right about 40% of the time: https://www.evidenceinvestor.com/how-accurate-do-active-predictions-need-to-be/

If you don’t want to trust your luck, then the best balance would be to hold all segments, pretty much in the weights they are in the market, then you get market returns with the least risk. I think that is what the efficient market hypothesis is about: you can’t get better risk adjusted returns than the market unless you have information about the market which no other significant participants have.

Exodi

I think the general definition is that portfolio balance refers to mix of bonds/equity/cash, not risk, cap, region, sector, etc - but you're obviously referring to the latter.

This is all entirely subjective, because someone with a 5 year horizon would want their portfolio to be significantly less risky than someone with a 50 year horizon. Some people like holding bonds, some do not. Some invest globally, some only focus on the S&P. Some investing in emerging markets, some only focused on developed equities.

While there is no one size fits all, as JohnWinder says above, if I had a gun to my head I'd suggest a tracker that reflects global market capitalization would be the closest.

Linton

My investment policy is based on balancing across size, nationality, sector, and value versus growth with the aim to keep the %s of these factors constant over time so reducing the effects of over-exuberence and despair.

I dont believe there is an ideal balance appropriate for everyone.  In particular if you do not need to acces your money for decades then going down this route is probably not worth the effort.  However being retired medium term volatility is of significant importance whereas high long term returns are less important than having sufficient returns. Having levers of control in control is also helpful for sleeping soundly in troubled times.

What allocations I look for correspond to my objectives and preferences.  In particular:
 - 25% Value with Growth and Blend evenly balanced
 - 55% large companies
 - Americas 43%, Europe(inc UK) 34% and Asia 23%
 - tech below 20% with no other sector being greatlu different to its allocation in a global index.

With this number of factors keeping rigorously and continually to the allocations is impracticable.  I would normally rebalance to keep things reasonably in line once a year.

aroominyork

Your starting point is fine. Look at geography, cap size, growth/value, and sectors, and then decide if/where you want to differ from a global tracker. Your starting point could be HSBC FTSE All-World Index, but bear in mind it only covers the top 90% of market cap (MSCI cover 85%) and is about 18% mid cap and 0% small cap, so if you want to truly track the market you have to get your small cap elsewhere.

My approach is similar to Linton's. I keep an eye on Geography - very roughly 40% N America, 30% UK/Europe, 30% AP/Japan/EMs; I keep an eye on small/midcaps - usually around 25%; I keep an eye on growth/value - currently 62.5%/37.5%. The growth is more than I would like, but my investment approach is to have active funds for UK small caps, EMs and Fundsmith (the Sustainable version) with the rest in index funds. I guess I could move some index funds into a value tracker like XDEV but I'd end up messing around more than I want to.

wanna_make_some_dough

Thanks everyone.  I had read about balancing based on bonds/equity ratios, geographical spread within this forum and also various ratios (P/E, alpha, beta, SD etc) but did not see any articles/posts on the usage of the ratios of investment styles or sectors.  I was trying to understand how does one make use of this data that the Morningstar X-ray churns out.  (Hence my query on whether these attributes are to be used for balancing at all  or are they just values for information.)

Many thanks again.

InvesterJones

wanna_make_some_dough said:

Thanks everyone.  I had read about balancing based on bonds/equity ratios, geographical spread within this forum and also various ratios (P/E, alpha, beta, SD etc) but did not see any articles/posts on the usage of the ratios of investment styles or sectors.  I was trying to understand how does one make use of this data that the Morningstar X-ray churns out.  (Hence my query on whether these attributes are to be used for balancing at all  or are they just values for information.)

Many thanks again.

For market cap weighted indexes/funds, investment styles and sectors will already be balanced according to market consensus on risk/reward. They're of use if you wish to take a decision against consensus (for example, if you believe a sector or style is better/worse than the rest of the investing world does then you can over/under-weight it in your portfolio). Or you may have some reason other than long term returns to over/under weight a particular sector or style.

aroominyork

On the question of value, there are two ways to increase exposure – active funds (special situations/recovery etc.) and factor funds. This article on ii.co.uk first mentions XDEV and IWVL which track the (sector neutral) MSCI World Enhanced Value index.

It then mentions PSRW, the more conversative RAFI approach based on dividend yield, free cash flow, total sales and book equity value: the top ten holdings include Apple, Amazon, Meta, Microsoft and Alphabet but none higher than 1.17%.

This compares five year performance to a global index fund.

This next table compares performance of PSRF, the RAFI for the US stock market, shown against a US index and an S&P equal weight fund (XDWE). What is interesting is how closely it tracks XDWE.

My question is whether there is something intrinsic about the RAFI methodology that makes it similar to an equal weight fund, and if a global equal weight existed would PSRW be likely to perform similarly?

Linton

aroominyork said:

On the question of value, there are two ways to increase exposure – active funds (special situations/recovery etc.) and factor funds. This article on ii.co.uk first mentions XDEV and IWVL which track the (sector neutral) MSCI World Enhanced Value index.

It then mentions PSRW, the more conversative RAFI approach based on dividend yield, free cash flow, total sales and book equity value: the top ten holdings include Apple, Amazon, Meta, Microsoft and Alphabet but none higher than 1.17%.

This compares five year performance to a global index fund.

This next table compares performance of PSRF, the RAFI for the US stock market, shown against a US index and an S&P equal weight fund (XDWE). What is interesting is how closely it tracks XDWE.

My question is whether there is something intrinsic about the RAFI methodology that makes it similar to an equal weight fund, and if a global equal weight existed would PSRW be likely to perform similarly?

I would guess the key difference between RAFI and the straight capitalisation weighted index in the US is the % allocation of the giant techs.  Both RAFI and equal weighting have a much lower allocation than the capitalisation index.  If this is the case the behaviour is specific to the US and could be quite different in the rest of the world.