As an investment strategy, asset allocation ensures that an investment portfolio is spread across a range of different asset classes to meet the varied needs of individual or institutional investors. It’s a vital, dynamic strategy for creating and balancing a portfolio, allowing targets to be set, reviewed, and balanced at key points during the investment term.
As with any financial decision, asset allocation requires significant investment knowledge and requires that investors make some important decisions. One of these decisions concerns where to put the firm assets. It is important for investors to determine what their own individual risk tolerance is and what their own expectations are for growth and return on their investments. While professional financial advisors can be a great resource in this area, it is important to remember that financial professionals are not stock market experts and are only advising on what they think is a good portfolio selection. It is important to be wary of advisors who offer stock picks as an alternative to advice about the appropriate portfolio allocation.
Asset managers and investment banks use asset allocation strategies across the three main asset classes, to ensure appetite for and exposure to risk is keenly balanced with optimum potential reward.
Three core asset classes include:
· Cash and equivalents
Asset allocation can involve a number of moving variables. Each of the three primary asset classes have varying levels of risk and return, have unique features and benefits and may perform differently over time. Straddling multiple funds and securities, risk levels can be set in line with the investor’s long or short-term goals.
Strategic Asset Allocation
Strategic asset allocations sets and sticks to a baseline policy for fund mix. Targets are set and the portfolio rebalanced from time to time, depending on outcomes. Risk tolerance and set timeframe for investment are two key features of strategic asset allocation. The strategy is sometimes compared to buy and hold strategies.
Strategic asset allocation is understood to be a rigid approach to a long term investment. Asset Managers and Investment Managers often recommend deviating in the short term with tactical investments, allowing portfolios to benefit from ad-hoc investment opportunities.
Tactical asset allocation
Tactical asset allocation is a moderately active strategy that allows asset managers to add additional value by capitalizing on unique market situations or thriving market sectors. Once short-term profits are achieved; the portfolio can return to the original asset mix. Fund managers and investors must be diligent and razor-focused in their approach, understanding when short term opportunities have been exhausted and return to the longer-term strategic position.
Creating robust strategies and tactics in fund allocation across more than one class can optimize the structure of returns and meet the key goals of the investment portfolio, with planned, predictable results in line with each variable.
A key appeal with asset allocation is the capability to adjust the asset mix and risk exposure if the desired returns are not achieved. Incremental alterations can be made and assessed until the fund meets its strategic financial objectives, and do so in a robust manner. However, this can be a time-consuming process within asset management, requiring asset managers and institutional investors to work together to optimize returns via fund allocation. Fund analysis and historical collective data on optimal asset mixes can be used to help predict fund behaviors and reduce uncertainties.
Asset allocation allows for bespoke strategies to be built that suit different types of investors and support them to achieve their strategic financial goals. If investors are risk-averse or require active portfolio management, other strategies can be explored, for example, insured asset allocation.
The importance of the right asset allocation
Asset allocation is understood within asset management, to be one of the most important decisions for investors. Allocation mixes are as unique as every portfolio’s goals. Whilst there is no magic formula, a planned, set, strategic approach can help steer the portfolio's success and determine investment results.