CFP- Level-1-IP and Asset Management (Global) Chapter 1-6

Strategic Asset Allocation 1. Seeks to identify and maintain a portfolio asset allocation appropriate for an investor’s financial goals, investment objective, time horizon, and volatility tolerance; 2. Makes no attempt to predict the direction or magnitude of short- term market volatility; 3. Is characterized by a fixed target allocation to each asset class in an investor’s portfolio; and 4. Requires periodic portfolio rebalancing in order to maintain the target allocation to each asset class. Strategic asset allocation is, therefore, not a buy-and-hold strategy. Friday, 15 July 2022 Investment Planning & Asset Management

Asset Allocation 1. Example of 6 Strategic Asset Allocation Profiles Return Balanced Aggressive Growth Growth Conservative Equities Income Fixed Secure Income & Cash To find the optimal mix for a given investor requires 2 things: Risk 1) Knowledge of opportunities in the capital markets 2) A full understanding of the Investor’s circumstances and preferences Friday, 15 July 2022 Investment Planning & Asset Management

Tactical Asset Allocation • Tactical asset allocation also involves allocating across different asset classes and rebalancing, but it differs from strategic asset allocation in that it attempts to predict which asset classes (or individual securities) will be the next to have gains/outperform other asset classes in the short term. • Funds are then allocated to those asset classes in anticipation of future gains. • This strategy boils down to security selection and market timing, and is practiced despite significant evidence that successfully timing the markets (or securities trading) is extremely difficult, if not impossible, to do on a consistent basis over time. Friday, 15 July 2022 Investment Planning & Asset Management

Asset Allocation Asset Allocation Strategies Source: (Credit Suisse 2013) Friday, 15 July 2022 Investment Planning & Asset Management

Core/Satellite Allocation • This approach has gained more acceptance in recent years from investment advisors. It is a combination of strategic and tactical asset allocation achieved by dividing a portfolio into a core holding of strategically allocated assets (often in low-cost, broad-based index collective investments or broad-based exchange-traded funds). • This core typically represents 70–80% of the total portfolio, and is maintained at the prescribed allocation through periodic rebalancing. • The remaining 20-30% of the portfolio is the satellite portion and is allocated to a tactical strategy (active management) to capture some excess gains (alpha) Friday, 15 July 2022 Investment Planning & Asset Management

Dynamic Allocation • Dynamic asset allocation is used primarily by institutional investors. As a result, other than knowing it exists, there is not much need for the average investment advisor to delve too deeply into its inner workings. • This type of allocation is used primarily to hedge a portfolio against big declines in value. To do this, the investment manager will shift between riskless and risky assets, making the changes in response to what is happening in the marketplace. • As portfolio values change, the allocation will change with it. You can understand how this requires more-or-less constant oversight, which is something institutional investors have the ability to do. Friday, 15 July 2022 Investment Planning & Asset Management

Rebalancing Strategies • Once an investor has determined an appropriate asset allocation, the portfolio will require periodic rebalancing to maintain its original focus and intention. Why? Over time, some assets will grow while others will shrink, based on market returns. • The goal will be to bring the portfolio back to its desired allocation. This probably will mean selling some assets that have shown strong growth and purchasing others that have not done as well. • Rebalancing is primarily about risk control, or making sure the portfolio isn’t overly dependent on the success or failure of one investment, asset class, or style. Friday, 15 July 2022 Investment Planning & Asset Management

Time-Based – Rebalancing Strategies This time-honored approach requires revising the portfolio asset allocation on a predetermined schedule. This could be every six months, every year, or some other time. Many investment professionals suggest rebalancing the portfolio once annually. While this may be beneficial, it may also mean increased portfolio expenses and potential taxes from realizing gains. It may also cause sales or purchases of assets that don’t need to be sold or bought at the time, or at least so frequently. Friday, 15 July 2022 Investment Planning & Asset Management

Threshold-Based- Rebalancing Strategies • Using this approach will require focusing on the degree to which assets in the portfolio have increased or decreased in value and, thereby, increased or decreased as a percentage of the portfolio. Assume one asset has gained 15% in value while another has lost 15% in value. • You can do an even swap and immediately bring the asset allocation back into balance. It’s not likely you will see such a clean increase/decrease scenario, so you will have to make some decisions about what to adjust and by how much. Friday, 15 July 2022 Investment Planning & Asset Management

Time and Threshold-Based- Rebalancing strategies • A reasonable approach is to evaluate the portfolio annually. • When doing so, you may find that you don’t need to make any changes. • If this is the case, don’t force a rebalance. • However, after your evaluation, you may determine at least some investments have moved from the target allocation, and by more than you want to see. Friday, 15 July 2022 Investment Planning & Asset Management

Active Management of Portfolio In a previous chapter we looked at Jensen’s alpha, and how to determine the degree to which an asset manager is adding value to the portfolio. The consideration of alpha brings us to the next portfolio decision: active or passive management. Active management, as the name implies, involves actively selecting securities based on the belief that doing so will allow the asset manager to achieve higher returns (after fees) than those produced by the market. Friday, 15 July 2022 Investment Planning & Asset Management

Passive Management Does not have to constantly work to produce excess returns and/or minimize risk, only to consistently fail at one or the other If the EMH is correct, it’s nearly (or fully) impossible to beat the market The past does not repeat itself, therefore, active managers have no real basis for their work Friday, 15 July 2022 Investment Planning & Asset Management

Active Versus Passive Management Which is better? The simple answer is a passive investing approach will likely generate market-level returns with lower fees and expenses. However, if you, or the asset manager you use can generate better- than-market returns, active management, at least in part, may make sense. In other words, you and the client must decide and from time-to-time revisit the decision. Friday, 15 July 2022 Investment Planning & Asset Management

Asset Allocation In his best-selling book, One Up On Wall Street, Peter Lynch, one of the most successful money managers of the last 50-plus years, offers some worthwhile suggestions for portfolio design 1. Keep return expectations realistic (neither too high nor too low). 2. If the best you can do is match market performance, buy index funds. 3. Long-term investing is generally more effective and efficient than short-term trading 4. Adapt the portfolio to changing client requirements, as necessary. Friday, 15 July 2022 Investment Planning & Asset Management

• Chapter 6 Ends here • All the very best Friday, 15 July 2022 Investment Planning & Asset Management