ASSET ALLOCATION STRATEGIES

Allocating your investments among different asset classes is a key strategy to minimize your risk and potentially increase your gains.

ASSET ALLOCATION STRATEGIES:

Many portfolios containing equities also contain other asset categories, so the management factors  

are not limited to equities. There are six asset allocation strategies

1. Strategic Asset Allocation: 

Under this strategy, optimal portfolio mixes based on returns, risk  and co-variances are generated using historical information and adjusted periodically to restore target  allocation within the context of the investor’s objectives and constraints. 

This method establishes and adheres to a base policy mix—a proportional combination of assets based on expected rates of return for each asset class. 

You also need to take your risk tolerance and investment time-frame into account. You can set your targets and then rebalance your portfolio every now and then.

A strategic asset allocation strategy may be akin to a buy-and-hold strategy and also heavily suggests diversification to cut back on risk and improve returns.

For example, if shares have historically returned 

15% per year and bonds have returned 12% per year, a mix of 50% stocks and 50% bonds would be expected to return 13.5% per year.

2.Constant-Weighting Asset Allocation:

Strategic asset allocation generally implies a buy-and-hold strategy, even as the shift in values of assets causes a drift from the initially established policy mix. 

For this reason, you may prefer to adopt a constant-weighting approach to asset allocation. With this approach, you continually rebalance your portfolio. For example, if one asset declines in value, you would purchase more of that asset. And if that asset value increases, you would sell it.

There are no hard-and-fast rules for timing portfolio rebalancing under strategic or constant-weighting asset allocation. But a common rule of thumb is that the portfolio should be rebalanced to its original mix when any given asset class moves more than 5% from its original value.

3. Dynamic Asset Allocation :

Another active asset allocation strategy is dynamic asset allocation. With this strategy, you constantly adjust the mix of assets as markets rise and fall, and as the economy strengthens and weakens. With this strategy, you sell assets that decline and purchase assets that increase.

Dynamic asset allocation relies on a portfolio manager's judgment instead of a target mix of assets.

This makes dynamic asset allocation the polar opposite of a constant-weighting strategy. For example, if the share market shows weakness, you sell shares in anticipation of further decreases and if the market is strong, you purchase shares in anticipation of continued market gains.

4.Tactical Asset Allocation: 

Under this strategy, investor’s risk tolerance is assumed constant  and the asset allocation is changed based on expectations about capital market conditions.

Over the long run, a strategic asset allocation strategy may seem relatively rigid. Therefore, you may find it necessary to occasionally engage in short-term, tactical deviations from the mix to capitalize on unusual or exceptional investment opportunities. 

This flexibility adds a market-timing component to the portfolio, allowing you to participate in economic conditions more favorable for one asset class than for others.

Tactical asset allocation can be described as a moderately active strategy since the overall strategic asset mix is returned to when desired short-term profits are achieved.

This strategy demands some discipline, as you must first be able to recognize when short-term opportunities have run their course and then rebalance the portfolio to the long-term asset position.

The asset mix in your portfolio should reflect your goals at any point in time.

5.Insured Asset Allocation: 

Under this strategy, risk exposure for changing portfolio values  (wealth) is adjusted; more value means more ability to take risks.

With an insured asset allocation strategy, you establish a base portfolio value under which the portfolio should not be allowed to drop.

As long as the portfolio achieves a return above its base, you exercise active management, relying on analytical research, forecasts, judgment, and experience to decide which securities to buy, hold, and sell with the aim of increasing the portfolio value as much as possible.

If the portfolio should ever drop to the base value, you invest in risk-free assets, such as Treasuries (especially T-bills) so the base value becomes fixed. At this time, you would consult with your advisor to reallocate assets, perhaps even changing your investment strategy entirely.

Insured asset allocation may be suitable for risk-averse investors who desire a certain level of active portfolio management but appreciate the security of establishing a guaranteed floor below which the portfolio is not allowed to decline. 

For example, an investor who wishes to establish a minimum standard of living during retirement may find an insured asset allocation strategy ideally suited to his or her management goals.

6. Integrated Asset Allocation: 

Under this strategy, capital market conditions and investor  objectives and constraints are examined and the allocation that best serves the investor’s needs  while incorporating the capital market forecast is determined. 

With integrated asset allocation, you consider both your economic expectations and your risk in establishing an asset mix. 

While all of the strategies mentioned below account for expectations of future market returns, not all of them account for the investor’s risk tolerance. That's where integrated asset allocation comes into play.

This strategy includes aspects of all the below ones, accounting not only for expectations but also actual changes in capital markets and your risk tolerance. Integrated asset allocation is a broader asset allocation strategy.

But it cannot include both dynamic and constant-weighting allocation since an investor would not wish to implement two strategies that compete with one another.