Strategic versus tactical asset allocation


As an investor, you focus on one thing: maximizing your risk-adjusted returns over the lifetime of the investment. How to make this goal a reality? The first thing to remember is that while higher risk correlates with higher potential return, a healthy portfolio should combine risk and safety. This is where asset allocation comes in. When you divide your portfolio into different asset classes with low correlation, you will achieve optimal returns in each class, while limiting losses.

Currently, there are multiple investment opportunities available, such as private equity, venture capital, structured credit, MLDs and offshore investments, etc. These have the potential to add an element of alpha to your portfolio. However, can they become an essential part of your portfolio? Probably not.

So, while it is well known that asset allocation is the cornerstone of a robust long-term portfolio, the first step to achieving this is to understand the two ways in which asset allocation can be carried out – strategic and tactical.

Strategic allocation is aligned with your core risk-return profile and aims to ensure portfolio stability around a defined objective. As part of this strategy, you can set target allocations for different asset classes, based on your risk profile, goals, time horizon and return expectations. Once done, as your needs evolve and the market changes, you can periodically rebalance the portfolio to stay aligned with your asset allocation strategy. It is a relatively less active technique.

The basic allocation is generally between 70 and 100% depending on the profile of the investor. This builds on your core strategy and helps you take an active stance on asset allocation and adjust exposure to asset classes based on short-term market trends and opportunities. For example, if the IT sector looks attractive for a short time, you might want to overweight the sector, which is a relatively active strategy that requires close market monitoring as well as agility in making decisions to capitalize. about the opportunities available. A good wealth manager can help you with research-backed themes and trends.

The tactical portfolio should generally be no more than 20-25% of the overall portfolio depending on product availability, lock-in and client comfort, and is generally intended for short periods.

How do you combine the two to optimize portfolio returns? Start by creating an investment policy with the help of a qualified investment manager that captures all factors such as asset class composition, yields, restrictions, cash flow, liquidity, etc. . This will help you arrive at your strategic asset allocation. However, remember to keep some liquidity in the portfolio as this will allow you to participate in emerging tactical opportunities.

An emerging trend within tactical allocation is to have an additional 10-15% allocation, for example, from core allocation to long-term tactical exposures through new investment trends that seek to increase returns like venture capital investment, start-up investments as well as international investment. In such cases, the switch from the main basket to the tactical basket could also be based on:

• Net returns (after taxes and expenses) of fixed income alternatives are 150-200 basis points higher than its core alternative.

• Theme within listed equity tranches not available in traditional portfolios. The sectoral/thematic PMS/AIF will constitute an important part of the tranche.

• Alternatives not available on traditional platforms – private equity/long, short, etc.

• International exposure through listed/unlisted equities, global fixed income and global alternative opportunities.

Periodic portfolio monitoring helps to limit the gains that these tactical opportunities offer by exiting at the opportune moment and waiting for the next opportunity to invest. However, never overdo it when rearranging the portfolio.

Nitin Rao is CEO of InCred Wealth

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