Investment Strategies - Asset Allocation

A further extension of investment strategy, asset allocation is a process that utilizes various means of risk control to apportion assets in a manner consistent with the objectives and constraints that the planner and client have codified in the investment policy statement. Whereas the strategy types in the prior chapter focus on implementation and risk management, asset allocation concentrates on the attainment of the appropriate mix within the framework of these two processes. Asset allocation serves to achieve appropriate diversification and is very much a dynamic process. Candidates can expect a number of questions on the processes and rationale behind portfolio diversification.

Strategic Asset Allocation
This is the long-term apportionment of asset classes and subclasses consistent with the client's objectives. Strategies may be passive, utilizing index funds or a buy-and-hold approach; active in pursuit of alpha through individual security selection or the use of professional management (separate account, mutual fund or alternative investment); or semi-active which entails some form of enhancement to a passive approach.

  1. Application of client life cycle analysis - the analysis of an investor's risk tolerance and constraints form the basis for the creation of the investment policy statement and subsequent asset and strategy selection.
  2. Client risk tolerance measurement and application - consultative questioning and a more thorough understanding of the client enable the planner to understand the client's ability to bear risk. Risk tolerance measurement should be part of the initial counseling and analysis that ultimately will lead to the proper formulation of investment policy.
  3. Asset class definition and correlation - the investment policy statement will define the asset classes needed to implement the appropriate strategy. Care should be taken in understanding their interrelation and degree of correlation that should be consistent with the strategy to be pursued.

Rebalancing
Rebalancing is nothing more than the systematic and periodic realignment of the portfolio to its target weights. The purpose of doing so is to prevent the portfolio's performance from being driven or dominated by one security or asset class or subclass. Securities whose value has increased beyond its portfolio target are sold and those which have experienced a decrease in value to below their target weight are purchased with the overall goal of keeping the portfolio in balance. Frequency of rebalancing is a consideration in taxable accounts. As it may generate a taxable event and entails transaction costs of buying and selling, rebalancing should not be conducted too frequently. These points are moot in a tax deferred retirement account where transaction costs may be less of an issue and no taxable event occurs.

Tactical Asset Allocation
Tactical asset allocation involves the periodic and opportunistic shifts between asset classes to take advantage of or avoid certain market tendencies. Such activity occurs within the context of the overall strategic asset allocation and is not designed to override it.

Control of Volatility
Risk management is a critical ongoing function pursuant to policy formation and strategy implementation. The investment policy statement, because it is designed to be consistent with the client's objectives and constraints, should have at its core a strategy for managing risk consistent with the client's ability to bear it.
Concentrated Stock Portfolio Strategies
Related Articles
  1. Mutual Funds & ETFs

    ETF Analysis: PowerShares DB Commodity Tracking

    Find out about the PowerShares DB Commodity Tracking ETF, and explore a detailed analysis of the fund that tracks 14 distinct commodities using futures contracts.
  2. Mutual Funds & ETFs

    ETF Analysis: PowerShares FTSE RAFI US 1000

    Find out about the PowerShares FTSE RAFI U.S. 1000 ETF, and explore detailed analysis of the fund that invests in undervalued stocks.
  3. Options & Futures

    Use Options to Hedge Against Iron Ore Downslide

    Using iron ore options is a way to take advantage of a current downslide in iron ore prices, whether for producers or traders.
  4. Mutual Funds & ETFs

    ETF Analysis: Vanguard Small-Cap Value

    Find out about the Vanguard Small-Cap Value ETF, and explore detailed analysis of its characteristics, suitability, recommendations and historical statistics.
  5. Mutual Funds & ETFs

    ETF Analysis: Vanguard Intermediate-Term Corp Bd

    Learn about the Vanguard Intermediate-Term Corporate Bond ETF, and explore detailed analysis of the fund's characteristics, risks and historical statistics.
  6. Mutual Funds & ETFs

    Top 3 Switzerland ETFs

    Explore detailed analysis and information of the top three Swiss exchange-traded funds that offer exposure to the Swiss equities market.
  7. Savings

    What Women Investors Are Doing Right

    Women's risk aversion, penchant for research – and lack of male-style "irrational exuberance" – means their investing strategies often put them ahead.
  8. Investing Basics

    Explaining Risk-Adjusted Return

    Risk-adjusted return is a measurement of risk for an investment or portfolio.
  9. Investing Basics

    Calculating the Margin of Safety

    Buying below the margin of safety minimizes the risk to the investor.
  10. Mutual Funds & ETFs

    ETF Analysis: PowerShares S&P 500 Downside Hedged

    Find out about the PowerShares S&P 500 Downside Hedged ETF, and learn detailed information about characteristics, suitability and recommendations of it.
RELATED TERMS
  1. Net Line

    The amount of risk that an insurance company retains after subtracting ...
  2. Political Risk Insurance

    Coverage that provides financial protection to investors, financial ...
  3. Maximum Drawdown (MDD)

    The maximum loss from a peak to a trough of a portfolio, before ...
  4. Gross Exposure

    The absolute level of a fund's investments.
  5. Priori Loss Estimates

    A technique used by insurance companies to calculate loss reserves.
  6. Value Of Risk (VOR)

    The financial benefit that a risk-taking activity will bring ...
RELATED FAQS
  1. Is my IRA/Roth IRA FDIC-Insured?

    The Federal Deposit Insurance Corporation, or FDIC, is a government-run agency that provides protection against losses if ... Read Full Answer >>
  2. Does index trading increase market vulnerability?

    The rise of index trading may increase the overall vulnerability of the stock market due to increased correlations between ... Read Full Answer >>
  3. What are common delta hedging strategies?

    The term delta refers to the change in price of an underlying stock or exchange-traded fund (ETF) as compared to the corresponding ... Read Full Answer >>
  4. How does being overweight in a particular sector increase risk to a portfolio?

    An investor who is overweight in a particular sector risks a loss in value for the portfolio if there is a downturn in that ... Read Full Answer >>
  5. What are the primary risks an investor should consider when investing in the retail ...

    The retail sector consists of companies operating in multiple industries such as specialty retail, general retail, food and ... Read Full Answer >>
  6. What risks do I face when investing in the insurance sector?

    Like all equity investments, insurance companies present investors with market risk. Insurance companies, like banks, also ... Read Full Answer >>
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!