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The Role of Asset Allocation

Asset Allocation: The Sum Is Greater Than Its Parts

Like many other themes in life, investing comes down to finding the right balance. Asset allocation essentially boils down to how money in an investment portfolio is divided, or allocated, across different asset classes. Different asset classes have different levels of risk and return so each asset class will play a very different role within a diversified portfolio.

The three main types of asset classes are equities, fixed income and cash (or cash equivalents). But there are also alternative asset classes – most notably real estate and infrastructure – that are garnering increased attention, particularly from institutional investors and pension managers.

How much money you allot to each asset class is typically based on your financial goals, risk tolerance and the length of time you plan to hold those investments. The mix, or allocation of those asset classes, can have a significant impact on your ability to achieve your financial goals.

Let’s look closer at these five asset classes:

Equities

Equities are considered to be a riskier asset class, but they also tend to offer the strongest potential for long-term growth. Equity investors can profit when the stock price of the company appreciates in value (i.e., capital gains) or when the company passes on a portion of its earnings to shareholders (i.e., dividends). Those capital gains and dividends are both taxed at a lower rate than the interest income offered by fixed-income investments.

Fixed Income

Fixed-income investments include corporate and government-issued bonds, guaranteed investment certificates (GICs), and other types of interest-paying securities. They tend to be less volatile than equities, but also tend to offer lower long-term return potential.

Beyond paying interest, fixed-income securities may also rise or fall in value for a variety of reasons, including: 

  • changes to central bank interest rate policies,
  • specific government or corporate events,
  • the outlook or strength of the issuers (as well as any changes to their credit rating), and
  • the broader macroeconomic environment.

Cash

Cash and cash equivalents (such as treasury bills and money-market securities) are considered to be the safest asset class. Typically, they’re used for capital preservation, as they offer modest interest income and no potential for growth. After accounting for tax paid on any interest, as well as the impact of inflation, cash or cash equivalents offer little in the way of gains.

Real Estate & Infrastructure

Real estate (which includes commercial and multi-family properties, as well as REITs) and infrastructure investments both fall into the category of alternative assets. However, they are becoming an increasingly important allocation for pension managers. 

Commercial real estate would include stores, shopping centres and office buildings; in short, non-residential properties used for commercial profit making. Multi-family residential real estate, on the other hand, is specifically intended for residential use. It could consist of a single multiple-unit dwelling or several multiple-unit dwellings within a complex. A REIT (real estate investment trust) meanwhile is a company that owns, operates or finances income-producing properties that may include commercial and/or multi-family real estate.

Infrastructure represents the physical structures and systems that society relies on - think toll roads, bridges, railroads, electric power grids and similar assets.

These two asset classes can provide cash flow with long-term appreciation, enhance your portfolio's diversification and act as an inflation hedge. Both real estate and infrastructure are tangible assets that can deliver stable and predictable income streams.

Balance Your Portfolio Wisely

Although asset allocation is a core component of any long-term investment strategy, many individuals don’t have the time or necessary expertise to create an asset mix that suits their specific investor profile and can meet their long-term financial needs. For example, if your asset mix is too conservative – thanks to an insufficient weighting to equities or alternative assets – you might compromise the growth potential of your portfolio and your ability to meet those long-term needs.

Starlight Capital offers exceptional portfolio management experience and expertise for both real estate and infrastructure. To determine how these asset classes can be optimally allocated for you, speak to your financial advisor.

© Copyright 2018 Starlight Investments Capital LP. All Rights Reserved.

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