Asset allocation is among the most important decisions that investors make. Asset allocation has an important role in a portfolio’s long-term return. We believe that modeling the asset mix is one important tool in determining an investor’s long-term strategic asset allocation. LCG’s approach to helping clients make asset allocation decisions is highly customized, and our proprietary software is a reflection of that. LCG’s internally developed systems are purposefully designed such that we are not beholden to a single model or set of assumptions. Examples of asset allocation modeling commonly used by LCG include:

Optimization “efficient frontier” model
Using historical risk premia of various asset classes, LCG develops initial estimates of future return, risk, and correlation. In our experience, Efficient Frontier models can be helpful in determining the optimal risk/ return trade-offs associated with different portfolios.

Historic “stress test” model
Using factual, historic data to understand how different portfolios have behaved in past market environments can be a very useful exercise. We have found Stress Test modeling to be particularly informative when evaluating a portfolio’s risk during adverse market conditions (e.g., the 1987 Stock Market Crash, the 1990’s Tech Bubble and the 2008 Global Financial Crisis).

Stochastic “Monte Carlo” model
LCG’s stochastic model allows our clients to use forward-looking asset class risk and return forecasts as part of the asset allocation decision making process. Our stochastic model uses probabilistic simulations in order to provide an estimated range of future outcomes based on a portfolio’s future estimates of risk, return, taxes and spending. In LCG’s experience, such modeling is most useful when evaluating best, worst and base case future returns and/or ending market values for a given portfolio.

Importantly, it is LCG’s philosophy that while models are powerful tools in determining what a portfolio’s asset allocation should be, they are generally ineffective at forecasting the future. At LCG, we recognize the limitations of asset allocation models and place an emphasis on understanding a client’s practical considerations when providing asset allocation advice.