A Word From The Advisor
Asset Allocation - Now More than Ever

The past year disappointed many stock investors no matter how large or sophisticated their portfolio. Just about everyone took painful hits relative to expectations, and depending on their age, relative to their time horizon.

Asset allocation is a vital component of wealth management. At Oakwood Capital Management LLC, we take asset allocation very seriously, because getting this decision right up front eliminates many challenges going forward. We emphasize the importance of revisiting your asset allocation annually or periodically—now more than ever. With this in mind, let’s consider the relative performance of bonds and stocks over the past year.

Performance by Asset
At Oakwood, bonds were rewarding for our investors this year. While plenty of bond funds were negative for the year, our bond portfolios were up, owing to selectivity and discipline. Oakwood clients predominantly holding bonds earned attractive returns and a steady stream of income. But in preceding years, many of these same clients questioned the viability of investing in bonds, as they missed out on the equity boom.

On the stock side, our global strategies provided a better experience than global benchmarks and international indices, due to their US bias. In the purely domestic stock portfolios, our defensive posture deftly avoided areas that inflicted the most pain on investors. For example, we were underweighted in financials, and we took profits in energy and money off the table in July when oil peaked around $147/barrel. Some of the securities we are holding have naturally declined, and we’ve used the opportunity for tax management, offsetting gains taken earlier in the year. In some cases, we are harvesting tax losses for clients. We recognize how valuable these losses can be in the future as investors can use them to reduce or even pay no tax on capital gains.

Many Oakwood clients hold balanced portfolios with a conservative blend of stocks and bonds. These are the clients who are best positioned to tolerate the inevitable market swings. Looking back on the year, they have experienced the attractive balancing characteristics of high-quality diversified portfolios.

Honest Self-Evaluation
For clients who are building their wealth, we can only strive to reassure you that things will get better. But if investors continue to take more equity risk in pursuit of high returns without the expectation and acceptance of volatility or risk, now is the time for honest self-evaluation. It requires genuine self-knowledge and self-discipline to recalibrate goals and expectations.

We also note that the Oakwood clients who are best able to tolerate the downturn are those who took the time to assess their risk profile and asset allocation during happier days. At every opportunity, we continue this discussion to stay current with changing events in our clients’ lives.

How We Allocate
When you commit a portion of your net worth to financial assets—for the liquidity and diversification they offer—then your next important decision is the asset mix.

Financial assets can be segmented into asset classes comprising small cap and large cap stocks, value and growth stocks, domestic, international, and emerging markets stock, government, corporate, and municipal bonds, and REITS (real estate investment trusts). Because each asset class plays a distinct role in the portfolio, the whole is often greater than the sum of its parts. Allocating intelligently among these securities allows investors to achieve attractive returns and meet their long-term goals with less price fluctuation, lower costs, and more consistency than if they took a less comprehensive approach.

Since no two investors are alike, there is no single optimal asset allocation. Each investor has his or her own unique risk tolerance, goals, and life circumstances that dictate the weightings of core and asset class portfolios. In general, the greater the proportion of stocks in a portfolio, especially small cap and value stocks, the greater the risk and the greater its expected return.

Another rudimentary gauge is the number 100 to 110 minus your age; this suggests a desired stock allocation, e.g., if you are 60 years old you shouldn’t hold more than 40 to 50% stocks. But rote formulas tend to trivialize a complex issue. The point is that as skilled professionals we have the experience, tools, ability, and commitment to help you reach your financial goals through all market cycles.

Rebalancing Act
Maintaining an asset allocation suitable to your specific risk profile requires periodic rebalancing. The motivation for rebalancing should be to maintain a consistent target asset allocation, rather than to pursue higher expected returns. If the portfolio is never rebalanced, the allocation can drift away from its initial target, which has an impact on the agreed-upon financial goals. For example, your portfolio may grow increasingly concentrated in stocks, which increases the risk over the well-balanced global portfolio you originally envisioned.

Like asset allocation in general, there is no one-size-fits-all rebalancing solution. The optimal rebalancing strategy will differ for each investor, depending on his or her unique sensitivity to deviations from the target allocation, transaction frequency, and tax costs.

What’s Next?
After almost all of Oakwood’s clients enjoyed outperformance in the up market of 2007, and then outperforming in the down market of 2008, what’s next? We contemplate a challenging first half of 2009 and a better second half of the year as the financial markets look ahead to an improving 2010. As value managers, we will weather this period and our value stocks should do well as markets improve. We are holding lots of cash—dry powder—in our US portfolios and less cash in our global strategies. These highly diversified global portfolios—with their scientific structuring and cost-effective design—do provide an extremely viable and intelligent approach to asset allocation and diversification of risk. Bonds will continue to effectively counter-balance the risks of the equity market for clients seeking lower risk.

It’s beneficial to revisit asset allocation no matter what your holdings or whether the market improves or remains difficult. It’s also important to determine whether a five or ten-year time horizon dictates your expectations. We have a range of tools—and solutions—at our disposal to aid in your wealth management experience. We use these tools to help you clarify your range of options. We look forward to continuing the dialogue with you in person.