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To achieve balance, focus on the whole

Note from Vanguard: Twenty years after Vanguard first offered comprehensive investment advisory services to institutional clients—primarily defined benefit (DB) plans, endowments, and foundations—Vanguard Institutional Advisory Services® (VIAS™) continues to be guided by four enduring principles intrinsic to our company since its inception: goals, balance, cost, and discipline. In this article, we discuss how VIAS works with clients to achieve balance by developing a suitable asset allocation strategy.

Because all investments involve risk, institutions must manage the balance between risk and potential reward through the choice of portfolio holdings. We believe the best place to start is the construction of an asset allocation suitable for the portfolio's objective. This is anchored in academia, where research has shown that 91% of portfolio movements can be attributed to strategic asset allocation, making the decision about which asset classes to include—and how much of each—the most important decision an investment committee can make.

Contribution to portfolio movements

Unfortunately, we find that too many outsourced chief investment officer (OCIO) managers focus on tactical or dynamic asset allocation and manager selection (or rotation), both of which can have relatively little impact on returns for broadly diversified portfolios. This can be a very costly and inefficient process, and the result is that many institutions have experienced performance that has fallen short of diversified market benchmarks.

VIAS works to ensure balance by focusing on your entire portfolio.

"We spend the vast majority of our time making sure that balance, the asset allocation, is steady over time," said Chris Philips, who leads VIAS. "We will rebalance to the asset allocation targets and revisit the asset allocation if a client's needs change."

VIAS uses tools such as forward-looking, random variable modeling and historical perspective combined with experience and judgment to develop asset allocation solutions for clients.

Vanguard's Investment Strategy Group developed the Vanguard Capital Markets Model®, a proprietary financial model using Monte Carlo simulation techniques. This model helps investment committees analyze the potential distribution of returns of various investment strategies, showing both the range of potential outcomes and the probabilities of achieving risk and return objectives. With this information, the investment committee has additional perspective to decide which strategy best aligns with its goals.

VIAS can help develop an asset allocation strategy that's right for your organization. We can leverage our deep experiences to provide you with guidance and ongoing support. Please don't hesitate to reach out and consult with your Vanguard team.

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• IMPORTANT: The projections or other information generated by the Vanguard Capital Markets Model regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. VCMM results will vary with each use and over time.

• The VCMM projections are based on a statistical analysis of historical data. Future returns may behave differently from the historical patterns captured in the VCMM. More important, the VCMM may be underestimating extreme negative scenarios unobserved in the historical period on which the model estimation is based.

• The Vanguard Capital Markets Model® is a proprietary financial simulation tool developed and maintained by Vanguard's primary investment research and advice teams. The model forecasts distributions of future returns for a wide array of broad asset classes. Those asset classes include U.S. and international equity markets, several maturities of the U.S. Treasury and corporate fixed income markets, international fixed income markets, U.S. money markets, commodities, and certain alternative investment strategies. The theoretical and empirical foundation for the Vanguard Capital Markets Model is that the returns of various asset classes reflect the compensation investors require for bearing different types of systematic risk (beta). At the core of the model are estimates of the dynamic statistical relationship between risk factors and asset returns, obtained from statistical analysis based on available monthly financial and economic data from as early as 1960. Using a system of estimated equations, the model then applies a Monte Carlo simulation method to project the estimated interrelationships among risk factors and asset classes as well as uncertainty and randomness over time. The model generates a large set of simulated outcomes for each asset class over several time horizons. Forecasts are obtained by computing measures of central tendency in these simulations. Results produced by the tool will vary with each use and over time.

• Advice services offered through Vanguard Institutional Advisory Services are provided by Vanguard Advisers, Inc., a registered investment advisor.

• All investments are subject to risk, including the possible loss of the money you invest. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.

• Diversification does not ensure a profit or protect against a loss.

(© 2017 The Vanguard Group, Inc. All rights reserved.)

This sponsored content was not written by the editors of the newspaper, Pensions & Investments, and does not represent the views of the publication, or its parent company, Crain Communications.