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Asset Allocation and Risk Aversion
in the Advisor Perspectives Universe
The AP database provides useful insights into how Registered Investment Advisors manage investments for high-
and ultra-high net worth investors. Investors of all sizes are betting heavily on non-US markets, primarily
using mutual funds, and larger investors show a clear pattern of risk aversion, as compared to smaller and mid-sized
investors.
Investors of all sizes are heavily invested in non-US securities. Non-US securities comprise 10.2% of the AP universe,
with the breakdown by account size as follows:
| Accounts |
Average Size |
% of Assets in non-US securities |
|
| Largest |
$3.7m |
10.0% |
View Data |
| Mid-Size |
$119k |
15.4% |
View Data |
| Smallest |
$15k |
13.9% |
View Data |
Even more striking is the use of mutual funds (rather than individual securities) as the preferred investment vehicle for
non-US securities. Approximately 56% of the non-US assets in the AP universe are in mutual funds, compared to only 17% of
the US assets. Ten of the top 25 funds in the AP universe are foreign equity funds, and these ten funds represent 48% of
the assets in the top 25 funds (View Data). RIAs may have
more confidence in their ability to select individual US securities and fewer information sources to evaluate individual
non-US securities. Additionally, there are fewer sources for investing in non-US securities through separately managed
accounts, as compared to US securities.
Another interesting phenomenon is that mid-sized and smaller investors are more heavily invested in non-US markets than the largest investors, by an additional margin of 4-5%. Smaller investors seem less risk averse and more tempted by the higher historical returns (at least in the recent past) offered by non-US securities1. Larger investors may be more disciplined about adhering to asset allocation targets than smaller investors. As non-US markets have risen dramatically, larger investors may have proactively rebalanced portfolios to keep non-US components in line with target allocations. Smaller investors may seek more growth and are necessarily more aggressive than larger investors, who do not accept the higher level of risk such aggressiveness brings.
The emphasis on non-US markets is predictable based on past performance. In 2006, the MSCI EAFE index of non-US securities in developed markets returned 27%2,
with the MSCI emerging market index returning 32.2%3, compared to 15.8% for the S&P 500 and 19% for the Dow Jones Industrial Average. This performance disparity has persisted in 2007, with the MSCI EAFE developed market index returning 9.4%2 and the emerging market index returning 9.5%3, whereas the S&P 500 has returned 6.8% and the Dow 6.7% thus far this year. Investors are placing bets on the recent strong performance of the non-US markets and expecting continuing superior non-US market performance.
The pattern of risk aversion among larger investors is also apparent in their overall asset allocation decisions.
Consider the following:
| Market Segment |
Largest Accounts |
Mid-sized Accounts |
Smallest Accounts |
| Equities |
63.7% |
73.6% |
72.2% |
| Fixed Income |
28.0% |
17.6% |
14.4% |
| Cash |
7.9% |
8.3% |
13.0% |
|
View Data |
View Data |
View Data |
Smaller investors have larger allocations to equities and smaller allocations to fixed income, implying less risk aversion.
Asset allocation within the US equity markets is the only area where larger investors do not show a clear pattern of risk aversion.
Smaller investors are placing larger bets on large cap stocks, with proportionately smaller allocations in mid cap and small cap
stocks:
| Market Segment |
Largest Accounts |
Mid-sized Accounts |
Smallest Accounts |
| US Large Cap |
66.9% |
68.6% |
73.6% |
| US Mid Cap |
20.3% |
21.7% |
16.9% |
| US Small Cap |
12.8% |
9.8% |
9.5% |
|
View Data |
View Data |
View Data |
The rates of return for US markets, by market cap, are shown below4:
| Market Segment |
2007 YTD |
2006 |
Index |
| Large Cap |
7.2% |
15.5% |
Russell 1000 |
| Mid Cap |
10.3% |
15.3% |
Russell Mid Cap |
| Small Cap |
6.1% |
18.4% |
Russell 2000 |
Although the mid-sized and smallest investors are weighted more heavily toward large cap stocks, large cap stocks have not exhibited substantially higher returns (as compared to mid cap and small cap stocks), either in 2007 YTD or in 2006. So, when looking at allocations within US equities, not only are smaller and mid-size investors more risk averse, but there is no clear indication that they are chasing higher historical returns.
In the US fixed income markets, the pattern of less risk aversion among smaller investors re-emerges, since they favor medium grade (riskier) bonds at the expense
of investment grade bonds:
| Market Segment |
Largest Accounts |
Mid-sized Accounts |
Smallest Accounts |
Corporate Bonds
(Investment Grade) |
77.7% |
65.0% |
58.8% |
Corporate Bonds
(Medium Grade) |
21.4% |
33.7% |
39.4% |
Corporate Bonds
(High Yield) |
.9% |
1.3% |
1.9% |
|
View Data |
View Data |
View Data |
| Market Segment |
Largest Accounts |
Mid-sized Accounts5 |
Smallest Accounts |
Muni Bonds
(Investment Grade) |
82.5% |
79.3% |
90.5% |
Muni Bonds
(Medium Grade) |
11.5% |
18.8% |
9.3% |
Muni Bonds
(High Yield) |
6.0% |
1.8% |
.2% |
|
View Data |
View Data |
View Data |
Summary of data evaluation from the AP universe:
- Investors in all segments are placing strong bets on the non-US markets, influenced by significantly higher returns in those markets over the past 18 months
- Mutual funds are the preferred investment vehicle for non-US markets
- Smaller and mid-sized investors appear to be less risk averse than larger investors. Smaller investors are more heavily invested in non-US securities, carry larger equity asset allocations, and invest more heavily in riskier corporate and municipal bonds. The only contrary indicator to this pattern is that smaller and mid-sized investors are somewhat less heavily invested in small and mid cap stocks.
- Although smaller and mid-sized investors may be chasing historically higher returns in the non-US markets (as compared to US markets), this pattern is not clearly exhibited in the market cap allocations by smaller and mid-sized investors (as compared to larger investors).
Footnotes:
Performance data is as of May 6, 2007. Data is updated every week and current data may differ from the data in the tables above.
- The AP universe contains data at the account level, not at the investor level. Investors hold many accounts, and high- and ultra-high net worth investors hold greater numbers of accounts. Thus, data at the account level is really just a proxy for data at the investor level.
- www.msci.com/eqpages/body_DM.S.0.html
- www.msci.com/eqpages/body_EM.S.0.html
- www.russell.com/indexes/performance/daily_total_returns_us.asp
- For the mid-sized and smallest accounts, the number of positions in municipal bond medium grade and high yield bonds is relatively small, so this data is less significant.
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