Asset Allocation

Asset Allocation

Asset allocation is a significant step in your portfolio management process. The initial step for the Portfolio Manager is to determine your required rate of return (7.5% in case of IPP as per assumptions). To achieve this we first must put in mind the protection of the principal. Our second goal is then to achieve the target rate of return. Implementing pre-determined asset allocation is a must to achieve required diversification (each asset class has a different risk and return characteristic). While most investors do understand this concept, they would still focus on which investment would outperform or whether equity markets would trend up or down. Although these are important considerations, many professional money managers believe that asset allocation is the most important decision for the Portfolio Managers.

Traditionally asset allocation classes include stocks, bonds and money market instruments. The desired allocation of funds can be achieved through different styles of asset allocation strategies known as Strategic Asset Allocation, Tactical Asset Allocation and Dynamic Asset Allocation.


At SAMI we believe our style is Dynamic Asset Allocation. Dynamic asset allocation is a portfolio management strategy that involves rebalancing a portfolio so as to bring the asset mix back to its long-term target. Such rebalancing would generally involve reducing positions in the best-performing asset classes while adding to positions in underperforming assets. The general premise of dynamic asset allocation is to reduce the fluctuation risks and achieve returns that exceed the target benchmark .
Our Asset allocation is based on the ratio of total market cap over GDP. The valuation indicator used by Warren Buffett is the percentage of total market cap (TMC) over the U.S. GNP. Since the actual difference between GNP and GDP is minimal, our stock market valuation based on the total market cap over GDP is a very good indicator. When the ratio is below 50%, the market is significantly undervalued. When the ratio is between 50% and 75%, the market is modestly undervalued. When the ratio is among 75% to 90%, the market is fairly valued. When the ratio is between 90% and 115%, the market is modestly overvalued. Otherwise, the market is significantly overvalued.

SAMI’s Viewpoint on IPP portfolio asset allocation models:

Before we have put our first dollar in an IPP, we have made an assumption of 7.5% annual rate of return for the life of IPP. At SAMI we feel it is our diligent duty to reach for at least 7.5% compounded rate of return on a revolving five years term keeping in mind two basic rules of investing from Warren Buffett:

“Rule No. 1: Never lose money.

Rule No. 2: Never forget rule No. 1.”

At Sami our asset allocations have two elements:

  1. We are Equity biased (we love if we can achieve maximum allocations to stocks).
  2. We put all our efforts to stay very conservative while exposing our portfolio’s to stocks

Reasons for being Equities/stocks biased:

Money Market instruments and bonds are investor’s loan funds to companies or governments in exchange for a bond that guarantees a fixed return and a promise of the return of the original loan amount, known as the principal, at some point in the future.

Stocks are a partial ownership of rights in the company that entitle the shareholder to share in earnings that may accrue over the company’s lifetime. Some of these earnings may be paid out immediately in the form of dividends, while the rest of the earnings will be retained. These retained earnings may be used to build a larger infrastructure giving the company the ability to generate even greater future earnings. Other retained earnings may be held for future uses like buying back company stocks or making strategic acquisitions. Regardless of the use, if the earnings continue to rise, the price of the stock will normally rise as well.

Why always conservative:

We are already in an investment category which has provided best returns over the last 100 years and as owners of businesses, stock holders will share bigger share of future earnings. Now if we can use focus approach and make principle protection as our primary focus and growth as secondary objective, we can achieve both of our basic goals i.e. principle protection and real rate of return. Just to add, the average age of business in our portfolio is 75 years (we are not venture capitalist) with a very strong balance sheet and above average earning yields in last 20 years of historical performance than their peer group.