Asset allocation: A new approach

An investment bucket list designed for wealthy investors.

Summary: Investing should always be done with a purpose in mind, but for wealthy investors often an asset allocation is often more about funding general living costs in retirement. The experts point to a bucket strategy designed to meet short-term needs and to take advantage of longer-term thematics.
Key take-out: A focus for wealthy investors should be to generate stable returns that meet the immediate cash-flow needs of the current generation while fulfilling aspirations for the next.
Key beneficiaries: General investors. Category: Investment portfolio construction.

Do the old rules for asset allocation really make sense for today’s super-affluent?

Ascent Private Capital Management, a unit of US Bank that caters to folks with $25 million or more, thinks it has a better way. The approach combines two increasingly popular techniques – one gaining traction with retirement-minded retail investors, and the other popularised by university endowments.

Ascent calls the strategy “purpose-based investing,” and it’s aimed at aligning a client’s assets with a psychological theory known as Maslow’s hierarchy of needs. The theory lays out, in order, basic human needs, such as water, food, and shelter, and more emotional concepts like self-esteem, creativity, and respect. Ascent aligns clients’ money along this hierarchy with four separate portfolios – security, lifestyle, wealth expansion, and social impact. The first portfolio funds immediate needs, covering a few years of annual bills, and is completely liquid, invested in cash and cash equivalents. The remaining three buckets ratchet up the risk, targeting increasingly higher returns.

Graph for Asset allocation: A new approach

Some Wall Street firms have promoted a similar retirement strategy, creating “buckets” of investments based on the client’s future needs for cash and principal appreciation. Ascent’s twist is a significant tilt toward hedge funds and private equity. While the bucket strategy essentially repackages the traditional 60/40 mix of stocks and bonds, Ascent’s portfolio draws from the endowment model popularised by Yale, Harvard, and other universities.

Many wealthy individuals want to align their money with their values, says Ascent president Michael Cole. “Ultrahigh-net-worth individuals don’t have to worry about retirement, so they can lock their money up in vehicles like private equity, with longer time horizons,” he says. Ultimately, these illiquid alternatives can maximise returns for long-term goals like philanthropy or passing wealth to heirs.

Before the financial crisis, some even pointed to the endowment model as the benchmark by which the wealthiest Americans should base their asset allocation. That’s an ongoing topic at Tiger 21, a peer-to-peer investment group whose clients average $23 million in assets. The problem with translating the endowment model to the wealthy is twofold, explains Michael Sonnenfeldt, head of Tiger 21. “Endowments can underperform, but replenish with new donations. Plus, an endowment is forever, and operates as such, irrespective of multigenerational issues like estate taxes,” he observes.

Indeed, when the private-equity-biased endowments of Yale and Harvard were crushed during the downturn – each by as much as 30% – Tiger 21 sought a new formula. The question, says Sonnenfeldt, is “how do I use the endowment model, but assume no new sources of capital and adjust for living in a taxable world?” The solution had to generate stable returns that met the immediate cash-flow needs of the current generation while fulfilling aspirations for the next.

Ascent started with strategies typical of bucket-based investing. The “security portfolio” is invested in cash, short-term bonds, and CDs to cover about two years’ worth of annual spending, in case of personal emergencies or unforeseen opportunities. The second, or “lifestyle,” portfolio funds the first bucket and targets a stable rate of return of about 4% to 6%.

Easier said than done. This is your fairly typical asset allocation of 60/40, equities to fixed income, but the volatility-avoiding ballast is a diversified selection of hedged fixed-income and long-short equity strategies in separately managed accounts with lower minimums and 14- to 60-day liquidity. “The idea is to create lower volatility in the underlying holdings and remove any overlapping risk associated with exposure to commodities, currencies, or correlations,” says Ascent CIO Daniel Rauchle. Ascent says back-testing shows this portfolio declined “significantly less” than the Standard & Poor’s 500 during 2007-08, “thus meeting its objective.”

The endowment model comes into play in the third portfolio, for “wealth expansion.” With lifestyle needs covered, private-equity vehicles take advantage of long-term thematic investments like the reurbanisation of America, emerging markets’ swelling middle class, or US energy resurgence. This portfolio seeks outsize gains, to be socked away for gifts or bequests.

A final bucket is more personalised but further aligns values with investing. It funds, for instance, a social-impact investment portfolio, or family entrepreneurship via a family bank.

Both Cole and Rauchle acknowledge that Ascent’s approach requires significant wealth, somewhere north of $25 million, which could be rich for many readers. Still, it’s worth pondering how the long-term focus of endowments can supplement the legacy plans of wealthy individuals.

This article was first published by Barron’s and is reproduced with permission.

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