Asset Allocation and its strategies
Asset Allocation
Asset allocation can be defined as a process of investing in a range of assets or investments in order to diversify and reduce the risk of the overall portfolio. Hence an investor may try to balance risk versus return by using a combination of different asset categories keeping in mind financial objectives, investment time horizon, life cycle stage, etc.
It is well established that different asset categories such as equities, fixed income or debt, gold, real estate perform or behave differently under different market conditions. In other words it can be said that since different asset classes are diverse in behaviour and characteristics they are not perfectly correlated.
Accordingly, diversifying a portfolio into various or different asset classes may be considered as one of the risk mitigation tools.
To use an analogy, it is normally recommended to eat a diversified and balanced meal comprising of vitamins, proteins, minerals, carbohydrates, fats, etc. Think of these as various ‘asset classes’, imagine consuming only one food category such as carbs, it might increase the overall health risk considerably!
[1]Academic research, specifically the Brinson, Hood, Beebower study done in 1986 on large pension funds, demonstrated that a significant component of portfolio return (more than 90%) was a result of asset allocation. A small part of portfolio return accrued on account of selecting individual securities and market timing.
Unfortunately investors’ spend a lot of time and energy on predicting the future winning stock, timing entries and exit into the market, as well as tactical switches between gold, equities, debt etc. There is no crystal ball available to investors or advisors which can help them pick future winners and hence a strategic diversification across various asset become imperative in order to reduce overall portfolio risk.
Few types of Asset Allocation Strategies
There are so many different kinds of asset allocation strategies prevailing in the market and a few of them is listed below:
Core and Satellite asset allocation: Investors may achieve their investment objectives using a combination of both passive and active strategies through the “core” and “satellite” approach. The core (main part of the portfolio which is usually larger) of one’s portfolio may be a low-cost ETF / Index Fund linked to a broad market index as this would give the true market returns. The satellite (smaller part of the portfolio) portion may be used for taking additional risk through various active strategies.
Strategic Asset Allocation: This strategy is long term in nature aimed at creating an optimal portfolio mix primarily between equities, fixed income, commodities, real estate that may give you the highest returns for your given level of risk. So, if you are young and therefore have a longer timespan of investment, you may be risk profiled as aggressive/moderate as your ability to take risk is higher. On the flip side, if the number of years available for you to retire is lesser, then you may be classified as conservative in terms of your risk profile.
Tactical Asset Allocation: This is very much short term in nature. Depending on where the markets may be, your advisor may suggest an approach where there may be a deviation from the strategic asset allocation approach. For e.g., you may want to reduce your equity allocation for a short-period as the markets may be on the higher side and get back to the strategic asset allocation once comfortable.
Conclusion
Diversification and asset allocation is one of the vital points for successful investing. Rather than focusing solely on predicting winners, diversification across asset classes is key to reducing overall portfolio risk. By adopting a disciplined approach to asset allocation, investors may be able to navigate market uncertainties and position their portfolios for long-term growth while managing risk effectively.
Source:[1]: Academic Research
Mutual Fund investments are subject to market risks, read all scheme related documents carefully
Please note that this article or document has been prepared on the basis of internal data/ publicly available information and other sources believed to be reliable. The information contained in this article or document is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party in any manner. The article does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article or document.
Published on 8 May 2024
