Vanguard’s Portfolio Construction Framework: From Investing Principles to Custom Portfolio Solutions identifies and defines four primary investment methodologies: market-capitalization-weighted portfolios; model-based strategic asset allocation; active-passive portfolios; and time-varying asset allocation.

From that starting point, the paper builds a universe of portfolio solutions aligned to various combinations of investor goals, investor preferences, and investment types and identifies the differences, use cases, and considerations for each.

“We show that no one strategy is superior to the others,” the authors say. “Rather, there are different portfolio solutions for specific investor goals and preferences.” 

The framework is at the core of Vanguard’s investment advice methodology, global model portfolios, and funds-of-funds multi-asset portfolios. And it is incorporated into Vanguard’s proprietary models, such as the Vanguard Capital Markets Model® and the Vanguard Asset Allocation Model, which enable customization of portfolios for Vanguard products.

It also builds on Vanguard’s Principles for Investing Success: set clear, appropriate investment goals; develop a suitable asset allocation using broadly diversified funds; minimize costs; and maintain perspective and long-term discipline.

The authors show that while market-cap-weighted portfolios represent a sound choice for many investors, others have goals and preferences that may require non-market-cap solutions. Some questions that come into play: how much to invest in actively managed strategies, what risk-return trade-offs are involved in environmental, social, and governance (ESG) investing, and how to incorporate illiquid private investments, such as private equity or hedge funds.

Identifying the investor’s priorities helps determine which of the four primary methodologies should underpin a portfolio. Market-cap-weighted investing is an efficient way to pursue market returns and get diversified exposure at low cost. But for more complex portfolio goals and preferences, the other three methodologies open up more options:

• Model-based strategic asset allocation uses projected long-term returns of broad asset allocations based on proprietary models. The models may add sub-asset-class tilts, such as value equities, long-term government bonds, commodity futures, or high-yield bonds.
• Active-passive methodology compares the risk-return trade-offs of an actively managed investment and a passive benchmark and creates a blended portfolio in keeping with the investor’s risk tolerance.
• Time-varying asset allocation relies on projected returns that vary over periods of about 10 years as market conditions and the broader economic environment change.

The portfolio framework focuses on three common investor objectives: pursuing the maximum wealth growth attainable within the investor’s risk tolerance; managing certain investment risks such as inflation risk, interest-rate risk, or volatility; and seeking a certain level of portfolio return through time to meet a funding need.

Applying the framework, the authors define 14 possible portfolio solutions covering investors’ most common financial goals and find that no single strategy is superior to all others. “There is no one-size-fits-all portfolio,” they write. 

Learn more. Read Vanguard’s Portfolio Construction Framework: From Investing Principles to Custom Portfolio Solutions.