Various types of asset allocation IN THE uncertain world of finance, we know that systematic investment and sticking to your

asset allocation hold the key to success. But wealth management experts use asset allocation strategies not only to create wealth, but also to protect it during volatile times. It is not the maximisation of returns, but optimisation of returns that becomes the goal of money managers. Asset allocation strategy has to be reviewed continuously. This process plays a key role in determining the risk and return from your portfolio. Broadly speaking, the portfolios asset mix should reflect your risk taking capacities and goals. Wealth managers use different strategies of building asset allocations and we outline some of them and examine their basic management approaches. ]Asset classes and strategies There are many types of assets that may or may not be included in an asset allocation strategy:

cash and cash equivalents (e.g., certificate of deposit, money market funds) fixed interest securities such as Bonds: investment-grade or junk (high-yield); government or corporate; short-term, intermediate, long-term; domestic, foreign, emerging markets; or Convertible security stocks: value, dividend, growth, sector specific or preferred (or a "blend" of any two or more of the preceding); large-cap versus mid-cap, small-cap or microcap; public equities versus private equities, domestic, foreign (developed), emerging or frontier markets commercial or residential real estate (also REITs)

natural resources: agriculture, forestry and livestock; energy or oil and gas distribution; carbon or water precious metals industrial metals and infrastructure collectibles such as art, coins, or stamps insurance products (annuity, life settlements, catastrophe bonds, personal life insurance products, etc.) derivatives such as long-short or market neutral strategies, options, collateralized debt and futures foreign currency venture capital, leveraged buyout, merger arbitrage or distressed securities

There are several types of asset allocation strategies based on investment goals, risk tolerance, time frames and diversification: strategic, tactical, and core-satellite. * Strategic Asset Allocation the primary goal of a strategic asset allocation is to create an asset mix that will provide the optimal balance between expected risk and return for a long-term investment horizon *Strategic allocation is typically the first stage in the investment process. Based on the investors long-term objectives, an initial portfolio is build. It is the backbone of any investment strategy. This often forms the basic framework of an investors portfolio. This is a proportional combination of assets based on expected rates of return for each asset class. For example, if stocks have historically given a return of 12% per year and bonds have returned 6% per year, a mix of 50% stocks and 50%

bonds would be expected to return 9% per year. Strategic asset allocation generally implies a buy-and-hold strategy. Strategic asset allocation defines the boundary of risk, and it is these boundaries that help control portfolio risk. The primary goal of a strategic asset allocation is to create an asset mix that will provide the optimal balance between expected risk and return for a long-term investment horizon. If you arent implementing a specific strategy to your current portfolio, chances are youre holding a strategic asset allocation and dont even realize it. With this type of allocation the investor simply picks and chooses different funds and asset classes that will hopefully minimize risk with offsetting investments that generate a return within a specific range. This is the most common type of allocation where investors typically pick a few stock funds and then offset it with a certain percentage of bond funds thats suitable for their age or risk tolerance. The idea is that you can strategically offset some of the risk from stocks by adding some safer investments such as bonds or cash equivalents. With that mix and the known expected historical returns of each type of asset you have a defined range in which you deem your portfolio successful. Strategic asset allocation is also the allocation that can benefit from regular rebalancing. Since you are primarily concerned with keeping your overall stock/bond mix incheck and therefore keeping your risk at a suitable level youll want to rebalance at least once a year as those ratios begin to skew from your target. Over time, either stocks or bonds will outperform the other and make you overweight in

one area and underweight in another. By rebalancing back to your target youre effectively taking some of your profit by selling high and reinvesting it in the asset that is lagging, therefore buying low. * Constant-Weighting Asset Allocation *Strategic asset allocation has its drawbacks as it entails a buy-and-hold strategy even if a change in the value of assets causes a drift from the initially established policy mix. This has driven the wealth managers to resort to the constant weighting asset allocation. This strategy helps you to continuously rebalance your portfolio. For example, if gold was declining in value, you would purchase more of it to maintain its weightage and if its value increased you would sell it. There are no hard-and-fast rules for the timing of portfolio rebalancing under strategic or constant-weighting asset allocation. Most wealth managers are of the opinion that the portfolio should be rebalanced to its original mix when any asset class moves more than 5-7% from its original value. * Tactical Asset Allocation method in which an investor takes a more active approach that tries to position a portfolio into those assets, sectors, or individual stocks that show the most potential for gains. *Over the long run, a strategic asset allocation strategy may seem relatively rigid. There are investors who constantly want to seek returns out of market opportunities that arise. Hence, investment managers find it necessary to go in for short term tactical calls. Such tactical calls create room for capitalisng on unusual or exceptional investment

opportunities. This is like timing the market to participate in the fluctuations and volatility that arise due to market conditions. While a strategic asset allocation is revisited once in six months, tactical asset allocations are visited every month. Tactical calls are on an ongoing basis. For example, shifting a part of the portfolio from large cap stocks to mid cap stocks to take advantage of the environment is a tactical call. We restrict our tactical calls around 10% of the total portfolio and rest of the money is strictly governed by strategic allocation, said a wealth advisor with a foreign wealth manager. Tactical allocations being opportunistic in nature, wealth managers prefer to maintain clear time-based and value-based entry and exit points to ensure better risk management. Think you have what it takes to beat the market? If so, tactical asset allocation is for you. With this method an investor takes a more active approach that tries to position a portfolio into those assets, sectors, or individual stocks that show the most potential for gains. Tactical investors arent concerned about owning the whole market or just sitting on a few index funds for years at a time. Instead, they try to ride the tide and buy into asset classes that are on the move. If youre someone who jumps out of stocks when things head south and move into bonds, or dump your money into gold because thats the current hot commodity, youre a tactical investor. But tactical asset allocation doesnt simply have to do with trying to find the current hot sector. You can also be a contrarian investor. A contrarian usually goes against the grain and instead of buying into the current hot investment they buy into something thats been beaten down in hopes that it is undervalued because nobody is paying attention to

it. This will hopefully result in investors coming back to that asset and driving the price up so the contrarian and eventually sell for a significant gain. Keep in mind that this type of asset allocation is riskier than others because it does take an active approach. Anyone can get on a hot streak or get lucky, but dont forget that even the best money managers in the world cant consistently outperform the market forever. This strategy is usually not well-suited for your long-term assets such as those used for retirement, but if you have an investment account on the side or simply limit this type of strategy to a small portion of your overall portfolio you can still try to take advantage of moves in the market without putting everything on the line. * Guided And Optimised Allocation *This can be seen as the advanced version of tactical asset allocation. When tactical asset allocation aims to take advantage of temporary situations in the market, the concept of guided and optimised allocation believes in squeezing the last drop out at all times. By very nature, it is meant for a bit aggressive investor. Here 75% of the clients portfolio could follow the original asset allocation, while 25% of the portfolio will explore opportunities where there could be chances of making higher return. So, investing in gold futures for a quick buck, or short-term corporate deposits offering higher rate of interest and such other opportunities remains on investors lookout. Here you must continuously stay tuned with the financial markets. The strategy further demands you to take into account transaction costs as the investors turn hyper active in

search of higher returns. * Dynamic Asset Allocation *For aggressive investors who want to ride momentum at times, managers recommend dynamic asset allocation. So, if the stock market is showing weakness, you sell anticipating a further fall. If it is going up, you buy anticipating a further rise. Here you constantly adjust the mix of assets as markets rise and fall. This is the opposite of constantweighting strategy. As the entire portfolio is available for action, amateur investors may turn hyper active. Especially in the high volatile times, acting on all types of information can lead to high transaction costs. Also, the tax treatment of the returns turns to disadvantages if you churn your portfolio too much. In times of high volatility, when the markets may not move up or down much, dynamic asset allocation is not advisable for nave investors. Depending on the type of investor you are, asset allocation could be active or passive. However investors should choose one keeping in mind their age, long term goals and risk taking capacity in mind. Core-Satellite Asset Allocation is more or less a hybrid of both the strategic and tactical allocations mentioned above Finally, we come to the core-satellite asset allocation strategy. This strategy is more or less a hybrid of both the strategic and tactical allocations mentioned above. Here, your portfolio is essentially made up of two components: 1. First, a core holding of stocks, bonds, or index funds make up the bulk of your portfolio. This is the strategic

component that uses the offsetting risk strategies mentioned above. The core of your portfolio may consist of anywhere from 50-80% of your total portfolio. 2. The remaining portion of your portfolio is your satellite allocation which may implement more of a tactical approach. While your core holdings make up the bulk of your portfolio and wont change much over time, your tactical component allows you to still scope out opportunities in the market. This is where you would take a more active approach and try to take advantage trends without risking your entire portfolio. This strategy is great for those who want to be more involved with their investments without relying entirely on their investment selection success. With the bulk of your holdings following a more passive approach you will still generally follow the market with relative ease, but you also have the potential to enhance your gains (and possibly losses) by managing some of the money on your own.

Systematic Asset Allocation is another approach which

depends on three assumptions. These are

The markets provide explicit information about the available returns. The relative expected returns reflect consensus. Expected returns provide clues to actual returns.

The Benefits of Asset Allocation Strings, woodwinds and brass. Stocks, bonds and cash. What do these very different things have in common? They are all parts of a whole and when they work together, they perform the way none could alone. An orchestra without violins wouldn't sound as good. And a portfolio without stocks just wouldn't offer peak performance. Asset allocation is important for portfolio performance. And what exactly is asset allocation? It's a systematic division and risk management of your investment dollars among various asset classes such as fixed income or equities. By having a portfolio that holds different types of investments, you help reduce your risk and portfolio volatility. Markets and asset classes do not move in tandem: What's hot today may be cold tomorrow. Spreading your investment dollars among different types of asset classes and marketsstocks and bonds, domestic and foreign marketslets you position yourself to seize opportunities as the performance cycle shifts from one market or asset class to another. Depending on your investment style and goals, your asset allocation will vary. Work with your financial advisor to create a personalized asset allocation for your portfolio. Stocks, commodities and bonds are subject to different risks. Stocks and commodities are also different from bonds, where bonds, if held to maturity, may offer both a fixed rate of return and a fixed principal value. Foreign investing has special risks, including currency exchange fluctuations, foreign taxes and possible delays in

settlements. Commodities may be subject to greater volatility. Foreign investing has special risks, including currency exchange fluctuations, foreign taxes and possible delays in settlement. Commodities may be subject to greater volatility. Many financial experts say that asset allocation is an important factor in determining returns for an investment portfolio.[2] Asset allocation is based on the principle that different assets perform differently in different market and economic conditions. A fundamental justification for asset allocation is the notion that different asset classes offer returns that are not perfectly correlated, hencediversification reduces the overall risk in terms of the variability of returns for a given level ofexpected return. Asset diversification has been described as "the only free lunch you will find in the investment game".[3] Academic research has painstakingly explained the importance of asset allocation and the problems of active management (see academic studies section below). Although risk is reduced as long as correlationsare not perfect, it is typically forecast (wholly or in part) based on statistical relationships (like correlation and variance) that existed over some past period. Expectations for return are often derived in the same way. When such backward-looking approaches are used to forecast future returns or risks using the traditional meanvariance optimization approach to asset allocation of modern portfolio theory, the strategy is, in fact, predicting future risks and returns based on past history. As there is no

guarantee that past relationships will continue in the future, this is one of the "weak links" in traditional asset allocation strategies as derived from[4]. Other, more subtle weaknesses include the "butterfly effect", by which seemingly minor errors in forecasting lead to recommended allocations that are grossly skewed from investment mandates and/or impracticaloften even violating an investment manager's "common sense" understanding of a tenable portfolioallocation strategy. Diversification is the foundation of an investment portfolio. While simply being diversified cant eliminate risk, it can help minimize your overall risk and protect you from catastrophic losses. But what does it mean to be diversified? Everyone tells us about how we need to diversify our investments, own stocks, bonds, real estate, cash, commodities, and everything else. That makes sense, but not many people explain how to go about it. Do you just buy an index fund or ETF that covers each type of asset? What percentage of each should you hold? And when do you rebalance your portfolio, if at all? One thing is certain, and its that theres no silver bullet allocation that will work for everyone. We all have different investment goals, risk tolerance, and time frames. We also know that just buying a bunch of funds does not always equal instant diversification due to fund overlap. So, before you begin picking a bunch of funds to add to your portfolio in order to become more diversified we first need to understand the basic types of asset allocation: strategic, tactical, and core-satellite.

Which Strategy is Right For You? Theres no right or wrong answer because it really depends on what youre comfortable with and how active a role you want to play in your portfolio. That being said, most people will probably benefit the most from taking a traditional strategic approach that consists of creating a tried and true mix of stocks and bonds suitable for their age and risk tolerance, but the recession and stock market performance has a lot of investors thinking twice about this strategy. Some have abandoned the strategic model completely and are now pure tactical investors, but Id caution anyone about making that drastic of a move. At least with your entire nest egg. Personally, I use the core-satellite approach. About 80% of my total portfolio consists of long-term and low-cost funds that give me about a 75% stock and 25% bond position. Then, I do have about 20% of my assets that I have more control over and use these funds to buy ETFs, funds, or individual stocks that I think will provide above average returns in a year or two. It has proven to be a decent strategy for the past four or five years. As a whole I typically perform on par with, or slightly outperform the market from year to year. In fact, 2009 was a great year for this strategy as I picked up a number of individual stocks at near record low prices such as GE, Abbott Labrotories, and Intel only to see them surge in price, boosting my returns on the year. So, what kind of asset allocation approach do you use? If you are thinking about adding some tactical investing to your portfolio its important to keep trading costs down as frequent trading and commissions can have a negative

impact on your total return. So, stick with a low-cost or free broker