Step 1: Paving the foundation

That is, set reasonable and suitable investment goals. This is the most important step and the foundation for all subsequent work.

Overseas, investment advisors spend a long time (often 1-2 months or more) closely communicating with investors before providing investment advice to ultra-high net worth individuals, sort out their financial status and needs, and conduct necessary education to help them clarify their investment goals.

Common investment goals include the following:

1. What is the expected return at the portfolio level? In what time period (3 years, 5 years, 10 years...)?

2. What is your risk tolerance?

Risk also includes multiple dimensions such as volatility (volatility), risk of capital loss (risk of capital loss), liquidity risk (illiquidity risk), and risk of not achieving expected returns (shortfall risk).

3. What are investors' requirements for liquidity?

For example, 50% of assets can be moved within 1 year.

4. What is the expected future cash flow of the portfolio (non-investment-related)?

Examples include expecting to spend 5% of the capital from the investment portfolio every year (for children's education, charity, etc.), or expecting 20% of new capital to be injected into the portfolio within 2 years (expected to be cashed out in future stocks).

5. What are investors' special preferences for different asset classes or investment strategies?

For example, some people are particularly fond of physical assets (real estate, gold, etc.), others don't believe in VC at all, and others like to invest in emerging markets, etc., all of these must be taken into account when allocating assets.

Step 2: Build a house

This is the process of formulating an asset allocation plan based on investment goals.

Based on the risk and return goals determined in the first step, use the Efficient Frontier (Efficient Frontier), or Markwitz model, to establish a broad range of asset allocations that meet the needs.

As we all know, the core of a model lies in its assumptions. The effective marginal model uses the assumptions of return and return profiles (risk and return profiles) and correlations for different asset classes.

Regarding these attributes, most professional institutions have their own proprietary assumptions. There are slight differences between institutions, but the differences are not that big, because after all, they are all empirical studies based on actual market performance. For example, the long-term yield of US stocks is about 7%, and the volatility rate is about 16%. This assumption is basically the same among different institutions.

Asset allocation is also divided into strategic (also called long-term or static) asset allocation and tactical (also called short-term or dynamic) asset allocation.

Strategic Asset Allocation (Strategic Asset Allocation) is a long-term, static allocation. It is a very long-term allocation based on investors' risk-return preferences. The long term here is generally 10 years or more. This configuration does not change with market conditions and is cross-cycle. The core assumption is that the market will return to median value in the long run.

Tactical Asset Allocation (Tactical Asset Allocation) is a short-term, dynamic allocation. It is a deviation from long-term allocation goals made by investors based on current market conditions.

A good asset allocation will form an artistic balance between the above two. It will not deviate too frequently or drastically from its long-term configuration; in other words, it is not excessive speculation. However, when we see opportunities where the market is undervalued or mismatched, we must act decisively. In developed countries, capital markets are more standardized and more predictable, so the tactical asset allocation of many private families is generally not too short term; generally, the investment period is 2-3 years. In China, the capital market is still underdeveloped and overall speculative, so the time frame for tactical allocations is relatively short, and half a year to 1 year is also quite common.

Step 3: Decorate and arrange the finished rough house

In other words, choose specific investment targets.

People can only live in a rough house after being renovated and furnished with furniture and appliances; similarly, even the best asset allocation must be implemented to specific targets before it can be achieved.

In other words, asset allocation mainly generates returns from a beta perspective, while the choice of specific investment targets generates alpha.

Assuming that 40% of the capital has been determined to allocate stocks, investors still need to make a series of decisions when making specific investments:

1. How much of it is directly invested (that is, select stocks yourself) and how much is an indirect investment (that is, entrust fund management)?

2. When diversifying investments, what kind of structure is used, equal distribution, or more complex structures: such as core-sattelite (core-sattelite), “donut” (donut) form, etc.?

3. Whether to adopt different investment strategies, including growth type, value driven type, trend type, etc. If so, how are the different strategies balanced and configured?

4. How to configure between different regions?

5. At the level of each specific target, determine the specific investment amount, timing (entry can be divided into multiple points of time), exit mechanism, etc.

All of the above decisions must be arranged according to the investor's own resources, including team, network of contacts, expertise, etc.

For example, family offices with large financial resources often have investment teams with specialized divisions of labor, and may also have the ability to directly invest in some fields;

However, for high-net-worth individuals, unless they have special resources or specialize in finance, it is more appropriate to use indirect investment and rely on professional financial advisors (different from sales of wealth management products) to give advice when time and energy are limited.

Step 4: Maintain and repair the house

That is, portfolio rebalance (rebalance).

Investing is a dynamic process. Although asset allocations do not change frequently, they also need to be reviewed and adjusted regularly. Just like the best house, it needs regular maintenance. Generally, rebalancing is carried out 1-2 times a year.

Reasons for the rebalance include:

1. Configuration deviation. Assuming that 40% of the stock allocation rises by 20% after a year, and the overall portfolio only rises by 5%, then the share share of stocks will increase to 46% after one year. The deviation of 600 basis points is quite large, and it is usually necessary to consider whether to transfer the currently overallocated share to other underallocated asset classes.

In other words, if a stock or fund has risen 20% in a short period of time, then it is likely that it is close to or reached a high valuation point, and it is time to lock in some of its returns and control downside risks.

2. Fundamental changes have occurred in specific markets. For example, 20 years ago, the expected return on PE in the US was generally above 20%, but currently the expected return of foreign LPs for the PE asset class is often only 15%, or some people use the stock market income plus 300-500 basis points (ilquiidy premium).

The reason is that as the PE market itself increases in efficiency, AUM increases, and competition intensifies, etc., the return rate of the industry as a whole has declined. In this case, it may be necessary to adjust the allocation of major asset classes.

3. The investor's own return risk appetite or capital plan has changed.

The above is a basic framework for constructing an investment portfolio. It is a relatively time-insensitive and, of course, relatively abstract method of operation. Many issues involved in the practical process need to be organized in a systematic manner.

Editor/Jeffrey