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The Croft Model Core Portfolio Mandates
 If you accept the notion that security selection delivers only a small fraction of the total return within a portfolio (85% to 90% of the return coming from the asset mix decision), then the most important decision for a client is the asset mix. That is, the percentage of stocks, bonds, cash, and other ancillary assets within a portfolio.
An investment strategy that allocates your financial resources among asset classes is referred to as
Asset Allocation. There are two basic formats your investment strategy can take:
1) strategic asset allocation; and 2) tactical asset allocation.
The Croft Model Core Portfolio Mandates utilize both strategic and tactical asset allocation within a tax-efficient framework. We begin by defining a strategic asset mix decision based on the client’s objectives and risk tolerances and then build out the bulk of the portfolio using our tax-efficient corporate share class structure.
We believe in the “strategic” decision to structure an asset mix in line with your investment personality. But we also believe in a range of choices for each asset class. Introducing a range allows some latitude to rebalance the asset mix while maintaining the long-term strategic intent of the portfolio.
In keeping with that theme, the Croft Core Portfolios (excepting the Conservative Income Mandate) employ a global tactical asset allocation overlay strategy delivered through the
Class A-1 Global Balanced Shares and Class C-1 Equity Shares (the Corporate Class Shares). We believe the combination of a strategic asset mix and strategic rebalancing, combined with tax efficiency and a global tactical asset allocation overlay, is an efficient way to manage a client’s portfolio within the context of the long-term objectives and risk tolerances.
What Is Strategic Asset Allocation?
Strategic asset allocation, sometimes referred to as policy allocation, is defined as a process of apportioning an investor’s portfolio among the broad investment classes – cash and cash equivalents, income assets, equities (including international equities), real estate, alternative strategies, and speculative assets. The introduction of different types of securities, particularly those that are less than perfectly correlated with each other, will reduce the variability of the portfolio and increase the likelihood that the portfolio will earn the required rate of return.
When we talk about strategic asset allocation, we are talking about an investment philosophy where you structure a portfolio based on your personal investment objectives and risk tolerances. For most investors, the range of appropriate asset allocation mixes is somewhere between 30%/70% and 70%/30% fixed-income assets relative to equity assets, spanning from growth to conservative.
Having established a strategic asset mix, the long-term management of the portfolio requires us to rebalance the strategic mix back to mandate either on a specific date or as a result of specific variations within the asset classes. For example, if one year later, the balanced portfolio has become weighted 60% to equity – because the equity markets outperformed the fixed-income and cash markets – 35% to bonds and 5% to cash, we would sell equity and buy bonds and cash.
The role of strategic rebalancing is to put in place a discipline that forces the manager to sell high – i.e., sell assets that have recently outperformed – and buy low – i.e., buy assets that have underperformed. The goal is always to rebalance back to the strategic asset mix.
What Is Tactical Asset Allocation?
Tactical asset allocation follows a very different track. With a tactical strategy, the manager’s focus is on weighting the portfolio to take maximum advantage of current market conditions. If, for example, the tactical manager believes that equities would outperform fixed income over the next period – the period could be one month, one quarter, six months, or even the one year – the manager would overweight equities and underweight bonds.
Sometimes the tactical manager is constrained within a range of asset mixes. For example, the equity mandate might be constrained to a weighting between 30% and 80% of the total portfolio. In this case, even if the manager believes that equities would outperform, he could not hold more than 80% of the portfolio in equities.
Some tactically managed assets, like the Corporate Class Shares, have no constraints. The manager can weight the asset mix in any combination that the manager believes will provide the best risk-adjusted return for the next period.
The Corporate Class Shares employ an unconstrained tactical asset allocation strategy. As such, the manager could have 100% of the portfolio invested in equity assets at a point in time. That much exposure to equity may not be suitable for some investors, if, for example, the Class C-1 Equity Shares were the only holding in the portfolio.
Further to that point, we should point out that studies thus far have indicated that market timing is extremely difficult. The rewards of making right decisions are high, but as Nobel prizewinner Paul Samuelson once said, “timing can be hazardous to your health.”
That is why we believe in the combined approach to portfolios, where the Corporate Class Shares are an excellent core holding, employed as the tactical component within an investor’s strategic asset mix.
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