Asset Allocation
Strategies
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Asset Allocation
Cash Stocks
An asset allocation is a strategy of
dividing the portfolio among various
asset classes so as to obtain the
desired portfolio characteristics to
suit distinct investor profiles.
Bonds, Stocks and Cash equivalents
are the most commonly used asset Bonds
classes in any asset allocation. It is an
organized and effective method of
diversification
The asset allocation for an investor depends on the investors
expectations of returns and the risk the investor is willing to take.
Investments : Key Determinants
The most important determinant of portfolio return is asset
allocation .
Security Selection 4.6%
Market Timing 1.8%
Other Factors 2.1%
Asset
Allocation
91.5%
Source: Brinson, Singer & Beebower
( 1991 )
Asset allocation
Asset Allocation encompasses the following:
Selection of the asset classes
Proper blending of these asset classes in a portfolio
Managing the asset mix over time.
Lifecycle Investment Guide
Mid Twenties La te Thirtie s to Ea rly Fo rtie s
10% 10%
5% R EAL ES TATE 5% R EAL ES TATE
C AS H C AS H
20%
B ONDS 55% B ONDS
30%
65% S TOC KS S TOC KS
Mid Fiftie s Late Sixties and b eyo nd
13% 15%
25%
5% R EAL ES TATE R EAL ES TATE
44% C AS H 10% C AS H
B ONDS B ONDS
S TOC KS
38% S TOC KS
50%
Asset Allocation Principles
Risk and return are related
Risk depends on the length of time one holds the
investment
Rupee Cost Averaging can reduce the risks of
investing
Risks that an investor can take depends on the
investor’s capacity to take risks and his attitude to
take risks.
Rupee Cost Averaging can reduce the risks of
investing-buy less when price is high & more
when price is low.
Period Investment Price per Share Qty of Shares
amount Purchased
1 Rs.150 Rs. 75 2
2 Rs.150 Rs.25 6
3 Rs.150 Rs.50 3
Total Cost Rs.450
Average Price Rs.50
Total Shares 11
owned
Weighted Average Cost: Rs. 40.91 ( 450 / 11)
Asset Allocation drivers
Asset allocation must take into account 2 factors:
Time horizon: the number of years you have to invest
Risk tolerance: your ability or willingness to endure
short-term declines in the value of your investments as you
pursue your long-term investment goal
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portfolio
Conservative Risk Profile
This profile is suitable for investors who prefer to preserve capital and
do not intend to taking any exposure to high risk investments. This
investment profile aims to obtain marginally higher return
predominantly through bank fixed deposits and a mix of debt schemes
and does not invest in equity or related instruments.
Moderate Risk Profile
This profile is suitable for investors who are willing to take an
exposure of upto 30% in higher risk investments like equity related
products with a medium term horizon in mind. This moderate equity
exposure is to enhance the returns on the portfolio.
Aggressive Risk Profile
This profile is suitable for aggressive investors who are willing to
invest upto 50% of their portfolio in equity related products and
clearly are well informed about the potential downside that could arise
in case of a sharp fall in the markets. Over the long term period of
upto 5 years this portfolio has the potential to outperform and deliver
above average returns.
What is Systematic Investment
Planning (SIP) ?
Systematic Investment Planning (SIP)
Disciplined way of investing fixed amount at a regular
frequency…. A time tested investment approach
Reduces the market risk by using the concept of rupee
cost of averaging
Allows power of compounding help create wealth over a
long term
Disciplined investing in equity funds over longer
time frames helps generate superior returns
Rupee Cost Averaging
In a falling market, SIP results in a better downside Protection
Mo n th N AV S IP Un its
Mar-00 70.87 1000 14
Ap r-00 64.55 1000 30
An investor would have
May-00 56.79 1000 47
lost 26% if he made a one
J u n -00 56.28 1000 65
time investment in March’00
J u l-00 61.66 1000 81
as compared to the SIP loss
Au g -00 53.99 1000 100
S ep -00 58.72 1000 117
of 7.6%
Oct-00 51.63 1000 136
No v-00 49.72 1000 156
Dec-00 53.01 1000 175
J an -01 52.28 1000 194
Average cost – INR 56.60
Rupee Cost Averaging…
Mo n th N AV S IP Un its
Mar-03 55.86 1000 18
Ap r-03 53.84 1000 36
May-03 54.77 1000 55 In the backdrop of a sharp
J u n -03 60.86 1000 71 rally , a SIP may under-
J u l-03 67.31 1000 86
perform than a single entry
Au g -03 73.91 1000 100
S ep -03 84.70 1000 111 strategy for a short period of
Oc t-03 87.62 1000 123 time.
No v-03 100.83 1000 133
Dec-03 106.23 1000 142
J an -04 124.22 1000 150
Feb -04 120.38 1000 158
Mar-04 129.35 1000 166
Average cost – INR 78.22
Asset Allocation Styles-Strategic Asset
Allocation
Strategic asset allocation is a method that establishes and
adheres to what is called a 'base policy mix'. This is a
proportional mix of assets based on expected rates of
return for each asset class
E.g. If stocks have historically returned 10% per annum
and bonds have returned 5% per annum, a mix of 50%
stocks and 50% bonds would be expected to return 7.5%
per year
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 choose to adopt a
constant-weighting approach to asset allocation. With this approach,
you continually rebalance your portfolio. For example, if one asset is
declining in value, you would purchase more of that asset; and if that
asset value is increasing, you would sell it.
There are no hard-and-fast rules for timing portfolio rebalancing under
strategic or constant-weighting asset allocation. However, 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.
Asset Allocation Styles-Tactical Asset
Allocation
In the short term, the investor may occasionally engage in
tactical deviations from the mix in order to capitalize on
unusual or exceptional investment opportunities
This flexibility adds a component of market timing to the
portfolio, allowing investors to participate in economic
conditions that are more favourable for the performance of
one asset class than for others
Asset Allocation Styles-Tactical Asset
Allocation
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 demands some discipline from the investor or
portfolio manager, as he or she 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
Asset Allocation Styles-Dynamic Asset
Allocation
Dynamic asset allocation is when the mix of assets is
constantly adjusted as markets rise and fall and the
economy strengthens and weakens
E.g. In a dynamic portfolio, if the stock market is showing
weakness, stocks are sold in anticipation of further
decreases in stock values, and if the market is strong,
stocks are purchased in anticipation of continued market
gains
Insured Asset Allocation
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 to try to increase the portfolio
value as much as possible. If, however, the portfolio should ever drop to the base
value, you invest in risk-free assets so that the base value becomes fixed. At such
time, you would consult with your advisor on re-allocating 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
might find an insured asset allocation strategy ideally suited to his or her
management goals.
Integrated Asset Allocation
With integrated asset allocation, you consider both your economic
expectations and your risk in establishing an asset mix. While all of
the above-mentioned strategies take into account expectations for
future market returns, not all of the strategies account for
investment risk tolerance. Integrated asset allocation, on the other
hand, includes aspects of all strategies, 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, albeit allowing only either dynamic or constant-weighting
allocation. Obviously, an investor would not wish to implement two
strategies that compete with one another.
Which Asset Allocation style is best ?
Asset allocation can be an active process in varying degrees or strictly
passive in nature.
Choice of a precise asset allocation strategy or a combination of
different strategies depends on one’s goals, age and risk tolerance
These are only general guidelines on how investors may use asset
allocation as a part of their core strategies
Allocation approaches involving anticipating and reacting to market
movements require a great deal of expertise and talent in using
particular tools for timing these movements.
Accurately timing the market is next to impossible, so make sure your
strategy isn't too vulnerable to unforeseeable errors
Fund Manager
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