July 14, 2022

MCF's Strategic Asset Allocation Dampens Volatility

black umbrella in falling rain


Stock market volatility, high inflation, surging gas prices, consumer fear – what investor wouldn’t question their investment strategy in these uncertain economic times?

But investors like Madison Community Foundation that follow a well-diversified and sound investment strategy focused on long-term returns understand that now is the time to be patient, not panic.

Influential investor and economist Benjamin Graham once said, “The best way to measure your investing success is not by whether you’re beating the market but by whether you’ve put in place a financial plan and a behavioral discipline that are likely to get you where you want to go.”

Through the adoption and maintenance of a strategic asset allocation strategy, MCF believes it has done just that.

What Is Strategic Asset Allocation?

Strategic asset allocation is the process of distributing investments across various asset classes, each of which may behave differently at a particular time. It considers an investor’s risk tolerance, investment time horizon and return objective to set strategic allocation targets. This allows investors to diversify their portfolios and reduce their dependence on the performance of individual investments. Once these targets are set, other than periodic rebalancing, the investor sticks with the allocation until their objectives or time horizon changes.

Because each asset class responds differently to different economic situations, a strategic asset allocation works to minimize volatility over the long term. By reducing volatility, asset allocation likely will increase the compounded portfolio return over time.

Exploring MCF’s Strategy

The chart below reflects MCF’s target asset allocation for its two permanent endowment portfolios as of 3/31/22.

pie charts showing asset allocation for MCF's diversified and ESG portfolios
Click to enlarge image

For decades, investors concentrated on three traditional asset classes – stocks, bonds, and cash or cash equivalents. This is the asset mix used in our environmental, social and governance (ESG) portfolio.

Of the three traditional asset classes, stocks have always been considered the most aggressive and volatile. But equities typically compensated investors for these risk elements with the most attractive total returns. Bonds, on the other hand, traditionally produced lower total returns than stocks, but their volatility also was lower.

Going Beyond Stocks and Bonds

MCF’s diversified portfolio goes beyond this basic allocation to include a healthy mix of what are often referred to as alternative investments: hedge funds, private equity funds, natural resources and real estate. These asset classes can further diversify a portfolio because historically their performance is not tied to that of traditional asset classes.

Private investments play a dual role: They compensate investors by potentially returning a “liquidity premium,” a return above what could be achieved by investing in public markets, and they act as a counterpoint to the volatility of public markets.

For example, real assets such as private natural resource and real estate investments protect against inflation, while a diversifying strategy, such as a hedge fund, is designed to protect the portfolio in a rising interest rate environment.

In the first quarter of 2022, MCF’s core real estate investment portfolio was up 7.7% and outperformed its benchmark by 30 basis points. This performance helped hold MCF’s overall portfolio return for the quarter to a loss of 2.95%, performing much better than the S&P 500, which lost 4.6% in the first quarter.

Protecting Future Returns Strategically

Strategic asset allocation is considered the most important investment decision an investor makes. It has proven to be effective, but it requires that investors stay the course and avoid making short-term, emotional decisions based on current market conditions.

Remember, what really matters is the portfolio’s ability to help us reach our long-term goal: to continue to provide support to the nonprofit organizations in our community and beyond that our fundholders have chosen to support. We do this by remaining focused on stability and long-term portfolio growth, maintaining the discipline required to ride out the economic uncertainty of the moment.