Asset allocation is the process of determining the most portion of financial resources available to institutional investors or corporate fund managers *eg: AMP, Deutche, Macquarie, BT, ING, Colonial) that is to be invested in specific asset classes such as shares, bonds, cash and property.
The major specific asset classes available include:
Shares
Bonds
Cash
property (either direct investment or indirect investment)
Both at a national and international level, given the globalization of investment opportunities and deregulation of the financial sector in recent years. other investments re also available, but are certainly not as substantive as the above major asset classes.
Some asset allocation examples would be useful here. At December 2005, the average asset allocation of balanced funds in Australia was:
Australian shares:            37.4%
International share:        27.4%
Listed property:                                7.6%
Australian bonds:             13.9%
Overseas bonds:              5.8%
Cash:                                     5.3%
Other:                                   2.6%

The asset allocation process is dynamic, for example in December 2002, the equivalent asset allocation was Australian shares (38.3%), international shares (26.6%), listed property (7.8%), Australia bonds (15.1%), international bonds (5.2%) and cash (4.3%).
At June 2004, the average asset allocation for superannuation balanced funds in Australia was:
Australian shares:            33.0%
International share:        21.1%
Listed property:                                2.6%
Unlisted property:           3.8%
Australian bonds:             14.5%
Overseas bonds:              5.6%
Cash:                                     6.9%
Other:                                   12.5%

This process of asset allocation to specific asset classes (eg: shares, bonds, cash, property) is very important, as studies have shown that up to 80% of investment results and performance are directly attributable to asset allocations, as opposed to specific stock selection (eg. NAB, or Westpac).
The importance of asset allocation is amply demonstrated with major “events” such as the October 1987 stock market crash, the dot.com collapse in 2000-01 and the downturn in the commercial property market in the early 1990s.
The stock market quote:
“bulls can make money, bears can make money, but the greedy pigs miss out”
Clearly highlights this asset allocation issue.
Why is asset allocation important? Clearly no one asset is the best performed asset every year. This is perfectly shown by analyzing asset class performance in Australia over 1985 – 2005 from the PCA. In particular:
Best performed asset class:
Shares (43% of years), bonds (10%), property (14%), LPTs (33%)
Worst performed asset class:
Shares (24% of years), bonds (29%), property (33%), LPTs (14%)
Similarly, within the property sector:
Best performed property sector:
Office (19% of years), retails (33%), industrial (48%)
Worst performed property sector:
Office (67% of years), retail (14%), industrial (19%)
So the key investment issue is selecting appropriate asset class weights for the investment portfolio and then drilling down into specific stock selection.
The following diagram illustrated the general approach to designing an investment portfolio; particularly highlighting the importance of a strategic top-down investment approach. This is more important at an asset allocation level than using a bottom-up approach.
How to design a portfolio

The following examples highlight the strategic role of asset allocation and the different level of assets held by institutional investors depending upon their strategic objectives:

The performance of these asset-specific options is measured against recognized investment benchmarks. Our aim is to outperform those benchmarks in each asset class over rolling one to three year periods.