The Hindu Business Line : Tactical asset allocation

MY FRIEND is a discerning trader. He ruthlessly cuts his losses and rides his profitable positions well. Importantly, he successfully engages in tactical asset allocation. What is asset allocation?

Most of us buy stocks and fixed-income securities such as bonds and fixed-deposits. These two categories of investments are called asset classes. The process of allocating money between these two asset classes is called asset allocation.

But why resort to asset allocation? One obvious reason is to diversify risk. If you do not expect the stock market and the bond market to fall at the same time, it makes sense to buy both stocks and bonds. So, if bond prices were to decline, your portfolio returns will not be badly affected because your investments in stocks would have done well.

Moreover, a study in 1986 concluded that asset allocation explains for 90 per cent of the changes in returns. This means that asset allocation is more important than security selection, especially for long-term investment.

But what is tactical asset allocation? Suppose you expect the RBI to increase interest rates. You would want to sell your bond portfolio, as rise in interest rates could lead to fall in bond prices. You may use that money to buy more shares or hold cash to buy shares at a later date.

Alternatively, you may expect the stock market to decline sharply. So, you may want to take profits on your equity portfolio and move into fixed-income securities. This process of frequently moving money between asset classes is called tactical asset allocation. Tactical asset allocation requires market-timing skills. Your portfolio returns will depend on shifting from one asset class to another at the right time. My friend excels in this strategy.

(The author is Head, Research, Navia Markets.)

More Stories on : Stock Markets | Investments | Simple Economics

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page