Introduction to Asset Allocation – Part IV

Guest Post – Tanumoy Hazra

Why is it so important to determine an Asset Allocation Strategy?

Expanding Options: The array of alternate investment options are growing day by day for investors. While they certainly make the portfolio construction process more complicated, they also provide new corridors for increasing potential returns while managing risk. It becomes important to, therefore, understand all options and then take an informed decision on which asset classes an you would want to choose and how much you’d want to allocate to each of them.

Risk Management: Your asset allocation strategy must make optimum use of diversification. This not only enables you to manage volatility by reducing risk and increasing potential returns, but also helps you ride the ups and downs of the market with more confidence.

Asset allocation strategies can be

Conservative	Moderate	Aggressive
with more exposure to debt	balance between debt and   equity	more exposure to equity

Determining the right asset allocation strategy will help you to successfully meet your long-term or short-term financial goals. For example, for long-term goals, an aggressive asset allocation strategy with more exposure to equity mutual funds may be preferred as it helps generate higher potential returns, while reducing risk and beating inflation in most scenarios. It may be better to invest in safer options or follow a conservative asset allocation strategy for short-term goals. Determining the right strategy will help you strike this balance.

Now, we delve into what “Strategic Asset Allocation” and “Tactical Asset Allocation” mean with respect to individual investors.

Strategic asset allocation is a long-term relatively passive approach

Strategic Asset Allocation: The asset allocation is determined for a long period of time and generally the weights determined during the planning process are used as a base guideline throughout the investing time horizon. A percentage of the portfolio is held in each asset class as defined by the SAA. The portfolio is rebalanced at regular intervals, or when it gets too far out of line with the desired allocations. The extent to which the portfolio is diversified will depend on the time horizon of the investor and their specific investment goals. Over time small incremental changes may be made to the asset allocation model, usually to reduce the risk as an investor approaches retirement age.

Tactical asset allocation is a more active, short term approach

Tactical Asset Allocation: This type of asset allocation is used to take advantage of tactical near-term opportunities that may arise in the market. In this approach allocations are adjusted based on market conditions and the relative valuations of various asset classes. This approach is often used to move capital from overvalued to undervalued sectors, countries or regions. Doing this effectively can significantly improve the risk-reward profile of a portfolio.

One way tactical asset allocation can also be implemented by using momentum. With this approach the allocation to each asset class only remains invested when prices are rising. A moving average can be used as a trailing stop, and when the relevant instrument’s price falls below the moving average the allocation is moved to cash or another asset class.

Asset allocation decisions often have more impact on a portfolio’s performance than individual security selection. Combining uncorrelated assets can not only reduce volatility but improve returns over time. A traditional asset mix will contain equities, bonds and cash. Adding alternative assets like real estate and hedge funds, especially Big Data and A.I. driven vehicles like the Data Intelligence Fund, can provide a unique opportunity to further reduce volatility.