Asset Allocation Strategies

¡Asset Allocation Strategies

¡Asset Allocation

¡Asset allocation is an investment strategy that attempts to balance risk versus reward by adjusting the percentage of each asset in an investment portfolio according to the investors risk tolerance, goals and investment time frame.

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¡Types of Strategies

I.Strategic Asset Allocation

II.Constant Weighting Asset Allocation

III.Tactical Asset Allocation

IV.Dynamic Asset Allocation

V.Insured Asset Allocation

VI.Integrated Asset Allocation

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¡Strategic Asset Allocation

¡A portfolio strategy that involves periodically rebalancing the portfolio in order to maintain a long term goal for asset allocation

¡At the inception the portfolio a base policy mix is established based on expected returns because the value of the assets can change given market conditions, the portfolio  periodically needs to be re-adjusted to meet the policy

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¡For example, if the stocks have monthly returned 10% per year and bonds have returned 5% per year, a mix of 50% stocks and 50% bonds would be expected to return 7.5%  per year

¡Primary goal of a strategic asset allocation is to create an asset mix that will provide the optimal balance between expected risk and return for a long term period.

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¡Constant Weighting Asset Allocation

¡Constant-Weighting asset allocation strategy is a moderately active portfolio management strategy. The strategy includes readjustment of portfolio in accordance with performance of assets.

¡Like strategic asset allocation, constant-weighting asset allocation strategy has a ‘base policy mix’, which is the proportion of portfolio to be allocated for each asset class like stocks, bonds, funds, real-estate, etc. 

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¡Those who follow constant-weighting strategy buy-and-hold assets according to the initial base policy mix; but they frequently rebalance their portfolio with respect to the performance (or price) of the asset

¡We can take example of gold in porfolio

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¡Over weighted securities can be sold to purchase under weighted securities

¡Although not a strict rule, most followers of this strategy returns to base policy when any asset class increase/decrease above 5% of initial value. 

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¡Advantage

¡Advantages of constant-weighting asset allocation strategy include predictable income and risk, better utilization of opportunities and portfolio diversification

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Tactical Asset Allocation

¡Tactical asset allocation (TAA) is a dynamic investment strategy that actively adjusts a portfolio’s asset allocation.

¡The goal of a TAA strategy is to improve the risk-adjusted returns of passive management investing.

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¡Passive management  is a financial strategy in which an investor invests in accordance with a pre-determined strategy that doesn't entail any forecasting

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¡Types of Tactical Asset Allocation

¡Discretionary

     In discretionary tactical asset allocation strategies, an investor modifies his asset allocation according to the valuation of the markets, in which they are invested. Thus, someone invested heavily in stocks might reduce their position when they perceive that other securities, such as bonds, are poised to outperform stocks.

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¡Systematic

¡Systematic tactical asset allocation strategies use a quantitative investment model to systematically exploit inefficiencies or temporary imbalances in equilibrium values among different asset classes

¡ TAA strategies use quantitative Trend Following or Relative Strength techniques

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¡This strategy allows portfolio managers to create extra value by taking advantage of certain situations in the marketplace. It is as a moderately active strategy since managers return to the portfolio's original strategic asset mix when desired short-term profits are achieved.

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¡This strategy demands some discipline, as one must be first able to recognize when short term opportunities have their course, and the rebalance the portfolio to the long term asset position

¡Dynamic Asset Allocation

¡It is direct opposite of constant-weighting strategy for example, if the stock market is showing weakness you sell stocks in  anticipation of further decrease and if the market is strong you buy stocks in anticipation of continued gains

¡Insured Asset Allocation

¡Insured asset allocation strategy is a fairly active portfolio management strategy which is ideal for investors with low-risk tolerance but who need active portfolio management.

¡ In insured asset allocation strategy investor establish a base portfolio value (often somewhere between 75% and 100% of total capital invested). Total portfolio value is not allowed to drop below this base value.

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¡When the total portfolio value is above the base value, then the investor practices active portfolio management strategies, such as investing in high-profit high-risk instruments like equities to maximize the portfolio growth.

¡when the total portfolio value drops to approach baseline manager moves to a passive mode by investing in low/no risk instruments and selling off risky instruments

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¡There are two major approaches available for insured asset allocation, formula approach and portfolio insurance approach.

¡In formula approach the investor buys more and more low/no risk assets when the portfolio is dropping to the base level.

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¡In portfolio insurance approach the investor use futures contracts and put options to insure the base capital

¡Integrated Asset Allocation

¡Integrated asset allocation strategy is a moderately active portfolio management strategy. It is practiced mainly by mutual funds, portfolio managers and some personal investors.

¡Integrated asset allocation strategy is somewhat complex as there are no fixed rules.

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¡Integrated asset allocation strategy integrates aspects of all other asset allocation strategies (dynamic, tactical, strategic, constant-weighing and insured asset allocation strategies).

¡Unlike other strategies, it gives nearly equal importance to future portfolio returns and portfolio risk tolerance. 

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¡Investors following integrated portfolio management strategy may or may not have investing preferences. Often they choose to invest a fixed portion of their capital in high-profit and/or low-risk investments and then adjusting the other portion according to market and product performances

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¡One major mistake often made by investors following integrated asset allocation strategies is simultaneously implementing opposite (competing) strategies. This makes portfolio management more complex and difficult, and can also result in capital loss.

¡Conclusion

¡Asset allocation can be an active process in varying degrees or strictly passive in nature. Whether an investor choose a precise asset allocation strategy or a combination of different strategies depend on that investor goal, age, market expectation and risk tolerance

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¡A well diversified portfolio is the best for consistent growth. It protect assets from the risk of large decline and structural changes in the economy over time. Monitoring the diversification of portfolio, making adjustment regularly can bring long term financial success.

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