Many models & techniques can be used to arrive at making tactical adjustment in clients’ asset allocation decisions, Gurpreet Singh points out
Introduction
Markets and asset classes do not move in cohesion. What is in vogue today may not find flavour tomorrow. Asset allocation has always been a key to achieving one’s financial objectives. While a static asset allocation decision has always been implemented by various financial advisors on one’s individual portfolios, the actual implementation do change over a period of time influenced by various factors like macroeconomic, market behaviours and advisory intervention by investors and planners. So does it really makes sense to keep the originally planned strategic asset allocation as a constant or one need to do the tactical asset allocation based on various internal and external factors?
Though we all practice this sacrosanct process in some form or the other on a regular basis, one must look at the most crucial factor of portfolio performance asset allocation with regard to the strategic or tactical components.
Spreading one’s investments across different types of asset classes and markets—stocks, bonds, alternative investment avenues in domestic and foreign markets—lets you position yourself to seize opportunities as the performance cycle shifts from one market or asset class to another. An asset allocation plan doesn’t have to be complicated to be effective, but it should include the four basic asset classes i.e. equities, fixed income, money markets and alternate assets. As one’s investment portfolio expands, the financial advisor may suggest additional refinements to broaden the asset allocation.
The goal of asset allocation is to combine investments with different characteristics so that the risks inherent in any one investment can be balanced by assets that move in different cycles or respond to different market factors. Since market tends to rotate from one segment of the market to another, asset allocation can also help you gain exposure to the right segment. You won’t have to guess which asset class is going to do well each year if you already have exposure to many different segments of the market.
Asset allocation: Strategic & tactical decisions
The strategic asset allocation in the portfolio is made initially and reviewed regularly with the client. After the strategic asset allocation and investment allocation comes the need to review these financial objectives over the agreed review period. While the decisions are made keeping longer or pre-defined investment periods, it is imperative to review the changed dynamics in clients’ financial standings and external environment.
This tactical decision reviews the current macro-environment and makes minor but important adjustments in the asset class allocation to optimise portfolio returns. Most organisations have their own asset allocation models, criteria’s based on risk profiling and the asset class in which they operate in. The compelling reasons for doing so are the changing market cycles, performance and outlook on various asset classes, availability of new & attractive investment opportunities in/out of the asset classes, achievement of desired financial results/lackluster performance of that asset class over a period of time. These compelling reasons have been responsible for the tactical asset allocation approach.
The decision entails moving assets out of the agreed percentages as per risk profile to new defined allocation as advised by planners. Tactical asset allocation may work as an adjustment tool in the above mentioned circumstances. Though one may agree it is temporary in nature to exploit/adjust to the changed circumstances, the tactical asset allocation may last a longer time than one would think.
Let’s analyse all arguments in & favour of strategic & tactical asset allocation (Please refer to table 1)
Table 1
Strategic | Tactical |
Asset allocation decision arrived at after factoring market changes & one’s financial objectives | Markets & financial objectives change dramatically over investors’ horizon period |
Markets & asset classes adjust over a period of time, hence no need of adjustments | A dynamic & adjusting investment decision works in favour of the client |
Regular risk profiling & asset allocation review not required unless asset allocation breaches pre-set allocations | Regular review of revising percentage asset allocation helps making better portfolio decisions |
An established and fool-proof way of asset allocation | It can enable exploitation of better market & product opportunities. |
Performance as per desired returns | Performance could be bettered by better performance of the revised allocations |
How to optimise asset allocation through various optimisation techniques
The decisions to change asset allocations are reviewed by investment committees, product managers or investment advisors themselves on a regular basis. The inputs required to make the tactical choices are very critical for the relevant decision makers.
There are models which can be built to provide the asset allocation optimisation to take tactical decisions in the portfolios. The models usually takes inputs from various macroeconomic factors such as GDP growth, inflation, interest rates, currency, past performance as well as futuristic expectations/views of the market and also contains the investors’ or wealth managers’ views. A reliable set of expectations about return, risk, and correlations is essential to building optimal decisions.
Wealth managers can use the robust optimisation inputs or incorporate these models to create their own asset allocation decisions. The kinds of reports which can be extracted through those models include optimal asset allocation, efficient frontier for asset allocation decisions, attribution analysis for risk-return analysis and sensitivity & scenario analysis. For predicting expected returns & reducing risk the following factors could be considered: Past performance, expected macro variables (GDP, inflation, etc.), EPS, interest rates/monetary policy, international market inputs and investor views can also be incorporated allocating based on optimised levels.
Asset allocation models
Asset allocation models need to take several factors into consideration while coming up with tactical allocations. Apart from over all investor objectives of return maximization and risk limits, other factors like market allocation, movement in economic factors, investors/advisor’s view, behavior of various asset returns become part of asset allocation model. How good an asset allocation is, would depend upon how each of these pieces are blended into the final model. Various steps towards achieving the right blend are described here and drawn in the flow chart A below:
Flow chart A
Conclusion
While strategic allocation may get justified for very long-term periods and static markets but in today’s ever-changing markets and investor awareness of market performance, a tactical approach holds an upper hand due to reasons discussed here. Thus it is imperative for advisors to keep a dynamic approach to investment decisions keeping the basic tenets of asset allocation in place to maximise portfolio performance using the models described above and implementing it in client portfolios.
The author is a Certified Financial PlannerCM, business consultant and an advisor.
Aug 10, 2022
Aug 10, 2022
Aug 10, 2022
Aug 10, 2022
Aug 10, 2022
Aug 10, 2022
Aug 10, 2022
Aug 10, 2022
Aug 09, 2022
Aug 09, 2022
Aug 09, 2022
Aug 09, 2022
Aug 09, 2022
Aug 09, 2022
Aug 09, 2022
The laws of the financial world are different from the physical world. You can have prolonged periods of time, when sanity takes a back seat and excesses happen.
R. Venkataraman Aug 20, 2021
Retail trading or day trading has exploded because of falling brokerage rates, democratization of information, higher transparency and mobile platforms.
R. Venkataraman Jun 15, 2021
My simple message for dear readers is, if you don’t have any desperate need for funds, then don’t do anything.
R. Venkataraman May 12, 2021
The blow up of a US hedge fund has resulted in WhatsApp university offering many courses on what went wrong with Bill Hwang and Archegos.
R. Venkataraman Apr 09, 2021
The expensive valuations have been sustained by strong rebound in corporate earnings which led to ~8% upgrade in FY22 Nifty EPS since October 2020.
R. Venkataraman Mar 26, 2021
We believe the interest rates are likely to have bottomed due to inflationary pressure, large government borrowings and normalizing credit growth. Hence rate sensitive sectors should be avoided in our view.
R. Venkataraman Feb 17, 2021
As markets make new highs, one gets more emails and messages, which highlight the accomplishments of traders who have found a formula for making money.
R. Venkataraman Jan 27, 2021
Data does not seem to convincingly prove that short periods of high returns are always followed by meagre returns. Only in 4 instances, we had negative returns in the subsequent year.
R. Venkataraman Jan 01, 2021
Since September end, Bankex is up 16% with large banks like ICICI Bank, Bandhan up 20-27%, Housing Finance Companies like Repco, LICHF, PNB Housing are up 50%-100% from their six-month lows.
R. Venkataraman Oct 13, 2020
Morgan Housel’s 'The Psychology of Money' explains in detail the role of human biases in investment decisions.
R. Venkataraman Sep 26, 2020
Per Order for ETF & Mutual Funds Brokerage
Per Order for Delivery, Intraday, F&O, Currency & Commodity