Updating my target allocation

The key to my investment philosophy is having a target asset allocation.  Ideally, this allocation hardly changes – perhaps a slight shift towards bonds and away from equities every year as the Grim Reaper approaches, but aside from that nothing significant. In practice, it’s time for a quick update to the allocation.

The main trigger for my allocation update, to coin Harold Wilson’s phrase, is: events, dear boy, events.  The portfolio I let a private bank manage for me was restructured last year, and left me with significantly more US exposure and less UK exposure than before.  And almost every asset class gained a lot last year, measured in pounds, so being levered proved to be a significant boon.  While I could rebalance, I want to consider whether my target allocation is still right.

My old allocation had UK equities and US equities equally weighted.  This left, when you factored in my bonds allocation, the UK at a target weight of 35%, and the US only slightly higher at 40%.  And my old allocation had bonds:equity  at 29%:71% – an equity-friendly mix, to be sure, but with a very significant minority of bonds.

Looking at my old allocation from current perspectives, I want to make some changes.

The UK is about 6% of global markets.  The US is about 50%.  I.e. almost 10:1 disparity. My current portfolio is 22:48.  So I’m overweight UK, and mildly underweight US.  How does this feel?  With the UK is in the middle of Brexit, which creates almost entirely downside risk to my mind, I am not especially keen to rebalance my UK exposure back up to 35%. As it happens pretty much all my assets outside my investment portfolio, such as property, shares in private businesses, etc are all based in the UK, so my UK exposure is much higher than it is in my investment portfolio. Given the Brexit uncertainties, I gulp.

And the US?  Yes, the US has Trump.  While Trump offers protectionism, anti-technology bias, deficit ballooning, and more, he also offers a clear pro-Business agenda, reduced US taxes, and a boost in US confidence.  So, while I don’t like being 8% over my target allocation, I don’t see the need to drop down the whole way.  In conclusion: I’m going to up my US target from 40% to 45% and reduce my UK target from 35% to 30%. This leaves my target exposure UK:US 30%:45% – still with significant home bias but less than before.  With my current exposure 22%:48%, I’m still overweight US and underweight UK, but by much less.

Now to equities vs bonds. A year ago, as I leveraged my portfolio, I wanted to reduce my portfolio volatilty.  To this end I upped my bonds target weighting to 40% (vs equities 100%, so 2/7ths, i.e. 28%).  This was contrary to my natural bias; I’m very comfortable with equities, have a variety of bond-like assets outside my investment portfolio, and can take a long term view, so overall I would aim for a higher-than-average equity weighting.  They say you should have your age in bonds; while I’m somewhat older than 28, I have plenty of other assets outside my investment portfolio.  So I’m more resilient to the portfolio falling in value than the textbooks would imagine, and think I can be comfortable with a higher equity weighting as a result. So as I now have 34% bond exposure, should I rebalance up to 40% or should i reduce my target?

Since I levered my portfolio a year ago, it has returned over 20% in a year.  In addition, I’ve paid off about a fifth of the debt.  So my level of risk has dropped significantly (pace @monevator’s well-observed comments elsewhere on this blog). I no longer feel the need to run a ‘low-risk’ allocation.  And while I’m a year older, what’s a year to us Keynesians?  In conclusion, I’ve opted to reduce my bond target from 40% to 35%. I’m still underweight bonds, but only marginally.

And finally, to leverage.  Originally I had hoped to be using proceeds from a house sale to eliminate most of my leverage.  But since this idea was shelved, I’ve been targeting a 40% debt exposure.  This is 2/7ths loan-to-value, i.e. about 29%.  Given that I’ve just benefited from >20% returns, my gut says staying leveraged this much is tempting fate.  Right now my margin loan is 38%, so in theory I should borrow some more.  This just doesn’t quite feel right; I’d rather be slowly paying down the margin loan with a view to reaching 10-20% in the long term. I don’t mind always being a few percent adrift of my target here so long as I’m moving in the right direction.  So I’m going to reduce my target debt exposure from 40% to 35%.  This leaves me slightly overleveraged (38% / 138% = 28% LTV).

The changes in my target allocation are summarised below.