What Is Asset Allocation and Why Should You Know It? (Part 2)

THE ASSET ALLOCATION IN THE CORRECT SELECTION OF ASSETS

Asset allocation is one of the final steps in creating a portfolio. However, the Asset Allocation is permeated by the entire portfolio design and creation process. We could not select and integrate assets into an investment portfolio without considering these issues (according to the investment policy and restrictions):

  • What type of assets is the most appropriate?
  • What degree of diversification would be correct?
  • How many assets will make up the portfolio?
  • What weighting (weight) will each asset have in the portfolio?

A financial asset can be a very good choice for a certain type of policy and strategy, but it can be harmful to other types of portfolios. It can also be very profitable, but it may be excluded because of its high level of risk (or some other restricted factor in the investment policy).

In short, Asset Allocation is not an isolated process and goes beyond value analysis. The first task is to decide the type of financial assets. Basically, the investor can invest in:

  • Fixed rent.
  • Equities
  • Cash.
  • Estate.
  • Raw Materials.
  • Derivatives and other assets.

Now, how is capital distributed among them? Will foreign markets be covered? What type of fixed income issues are appropriate? What kind of company actions is the most suitable? …

If the analysis of financial assets is complex in itself, in order to answer these questions, the collaboration of finance professionals, people specialized in the management of investment portfolios, is necessary.

But the task does not end here, then, comes everything related to the combination of assets (weights, correlations, etc.).

Keep in mind that different types of assets behave differently depending on the conditions in the market. Sometimes the equity works very well. It is also possible that large-cap stocks are the ones that outperform the market.

To overcome this handicap and send investments to anyone, the investment funds were created: it is invested directly in a portfolio built by a professional manager, with a policy and a level of risk known in advance by the investor.

WHY IS THE ALLOCATION OF ASSETS IN AN INVESTMENT IMPORTANT?

Asset Allocation has a very close relationship with the correct diversification. In turn, the correct diversification aims to mitigate the risk. Ergo, the Asset Allocation is a way of investing, achieving maximum profitability with the lowest possible risk.

The task of asset allocation, as we have observed, not only takes into account the “what” (what assets should I include?) but also the “how much” (how much should I invest in each of the selected assets?).

Depending on the economic conditions, the general market behavior, and the factors of each asset taken individually, some assets will increase their value, while others will decrease it. The point is to find a balance among all to manage volatility and, in global terms, to achieve a better evolution than the reference market.

Studies have been carried out that show that in investment, it is more important to think how much money to put in each type of asset than the types of concrete assets in which to invest (Determinants of portfolio performance, Financial Analysts Journal, July / August 1986).

The correct allocation of assets can achieve better results than the market as a whole. In fact, professional investment portfolio managers have a market as a reference and, through management, try to beat the performance of that market.

To measure the work of a portfolio manager, a ratio called “Jensen’s Alpha” (or simply Alpha) is used. The Alpha measures the talent of the manager in the composition and management of the portfolio, based on how many profitability points (always adjusted for risk) he obtains above his benchmark.

In summary, the Asset Allocation is important because it allows you to create an investment adapted to a series of conditions. It is the investor himself who decides what the ideal conditions are for his interests. For this reason, there is such a wide universe of investment funds: each fund is designed with policy and for some purposes. It is difficult not to find an investment fund adapted to each type of investor.

Leave a Reply

Your email address will not be published. Required fields are marked *

Solve : *
19 − 1 =