strategic asset allocation – All You need to know


Strategic asset allocation is a portfolio strategy
In addition, the investor sets a target asset allocation and rebalances it periodically.
Moreover, the portfolio will be rebalanced to bring back the asset allocation percentage, which was the original allocatin.
As the returns from the different asset classes are different, their weights will change after a period of time.
In order to bring back the weights to the original, rebalancing will be done.
strategic asset allocation
In this strategy, the allocation will depend on several factors like investors risk appetite, age, time horizon, investment objectives, etc.
In addition, the allocation may change over the period if the above parameters change.
And this strategy is compatible with the buy-and-hold strategy, unlike tactical asset allocation.
Moreover, tactical asset allocation is more suited to an active trading approach.
example…
Let’s assume Mr. X invested Rs. 4,00,000 in equity, Rs. 4,00,000 in fixed income, and Rs. 2,00,000 in cash out of 10 lakh he has.
Which means 40% equity, 40% fixed income, and 20% cash; this is his strategic asset allocation strategy.
In addition, the returns expected from equity, fixed income, and cash are 15%, 8%, and 5% in a year, respectively.
After one year, the weights will change as the returns are different for different asset classes.
You can see in the above image that the total value became Rs. 11,02,000 and new weights for equity, fixed income, and cash became 42%, 39%, and 19%.
But the original weights at the beginning are 40% equity, 40% fixed income, and 20% cash.
In order to bring back to the original weight, we need to sell a portion of the asset where the weight is higher than the original and invest in the asset where the weight has decreased.
You can see in the above image that the ideal amounts should be with the original weights assigned.
And the row is named “B.”.
In addition, the row values after 1 year are named “A.”.
Finally, if you subtract row A values from row B, you will get to know which asset to sell and which asset to buy.
In the above image, you can see that X needs to draw Rs. 19,200 from equity, buy Rs. 8,800 in fixed income, and buy Rs. 10,400 in cash to bring back to the original weights in asset allocation.
However, you need to remember that doing rebalancing is beneficial if there is a significant change in the target asset allocation.
Again, I mean, for example, if equity exposure becomes 50% greater than 40% originally assumed, rebalancing works very well.
And doing rebalancing when there is just 1% change in target allocation may not give better results.
As it will be difficult to capture 1% fall or 1% rise from the asset classes.
Because its quite common for the assets to rise or fall in a day.
So, capturing such minor rises or falls is very difficult.
Finally, it is advisable to try to rebalance when there is a bigger change in weight, i.e., 5% or more change in weight in any asset.
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