Asset Allocation Strategies: Methods for Portfolio Success

In investing, no single type of asset does well in every market. That is why it is important to have a plan for how to spread money across different investments, not just pick them at random. The right mix can help lower risk, make the most of opportunities, and keep long-term goals on track — even when markets change suddenly. This article explains the main ways to do this and the methods to keep a portfolio balanced over time. Let's first try and understand what Asset Allocation is:

What is Asset Allocation?

Asset allocation is an investment strategy that aims to balance risk and reward by dividing a portfolio’s assets according to a person’s objectives, risk tolerance, and investment horizon. It involves distributing assets in a way that supports a specific financial plan. Based on an individual’s risk profile and expected returns, this allocation is typically divided into two main categories: equity and debt, with a portion held in cash or equivalents. Therefore, understanding one’s financial goals and risk–reward ratio is essential for making the right asset allocation decisions.

Why Do You Need Asset Allocation for Financial Success

It is difficult to predict which asset class will perform best in any given year. Relying on a single asset class can be very risky.

According to the principles of asset allocation, different asset classes tend to deliver returns that are not perfectly correlated. Diversifying across them helps reduce overall risk by lowering the variability of returns for a given level of expected return. This makes it essential to understand both the investment goal and the time horizon. A well-balanced mix of asset classes is more likely to match an investor’s expectations for risk and potential returns.

Asset Allocation for High-Net-Worth Investors

For people with large investment portfolios, asset allocation is not just about lowering risk. It is also about protecting and growing wealth for the future. Bigger portfolios often include investments in different countries, asset types, and currencies that makes it even more important to get the mix right. High-net-worth investors may also add alternative investments, like private equity, real estate, or hedge funds, along with regular equity and debt, to spread risk and find more opportunities. In such cases, asset allocation is highly customised, with advice from expert teams and regular updates based on market trends. Citigold Private Client has carefully designed products and services, to provide a private client banking experience in UAE to help such investors manage and grow their wealth.

Types of Asset Allocation Strategy

We can broadly classify Asset Allocation Strategy into two parts:

Strategic asset allocation (SAA)

It refers to asset allocation that aims to achieve the investor's long-term investment objectives. It is based on longer-term risk and return outlook for the asset classes.

Tactical asset allocation (TAA)

It aims to take advantage of perceived inefficiencies / imperfections in asset pricing in the short-term, to extend arbitrage opportunities between two imperfect markets. The aim is to enhance returns in the shorter term.

Which asset allocation strategy to implement will depend on the investor's requirement and investment horizon

One thing which is mandatory for someone opting for SAA strategy is how to re-balance the portfolio in response to market fluctuations that move the asset allocation of the portfolio, since TAA accounts for these assumptions in shorter term.

Asset Allocation Strategies for Effective Re-Balancing

Buy and Hold

A buy-and-hold strategy is a 'do-nothing' strategy. It is characterized by an initial mix that is bought and then held till the maturity or time horizon. No re-balancing is required; no ongoing monitoring is required and therefore, this has low fund management costs.

Constant Mix

The constant-mix strategy implies a constant proportion of the portfolio to be invested in equities. Whenever the relative values of the assets change, the investor has to buy and sell to the desired mix. In general, re-balancing to a constant-mix requires the investor to buy equities as they fall in value and sell equities when they rise in value.

Constant Proportion Portfolio: Smart Asset Allocation Strategy

This is a portfolio rebalancing method in which the investor sets a “floor value” for the portfolio and allocates assets accordingly. In Constant Proportion Portfolio (CPP), the two asset classes are typically equity-dominated assets and debt equivalents such as bonds or cash. The percentage allocated to each asset class depends on the “cushion value” — defined as (current portfolio value – floor value) — and a multiplier coefficient, where a higher multiplier indicates a more aggressive strategy.

The amount invested in equities is calculated as: (Multiplier) × (Cushion Value) The remainder is invested in the other asset class. As the portfolio value changes, the investor rebalances using the same formula. The multiplier is based on the investor’s risk profile and is usually determined by identifying the maximum periodic loss the investor is willing to accept. The multiplier is the inverse of that percentage. Example: If an investor decides the maximum acceptable loss is 20%, the multiplier will be (1 / 0.20) = 5. Assume a portfolio worth AED 1,000,000, with a floor value of AED 900,000.

• If the portfolio value falls to AED 900,000, all assets would be moved to cash or other risk-free options to preserve capital.
• At the start, the allocation would be: 5 × (AED 1,000,000 – AED 900,000) = AED 500,000 in equities, with the remainder in the debt asset class.
• If the portfolio drops to AED 900,000, it would be rebalanced, as this is the predetermined floor value.

As part of a financial plan, asset allocation plays a vital role in achieving long-term goals. It is important to regularly review allocations and rebalance the portfolio to ensure alignment with the set goals and assessed risk appetite. Licensed content from: https://wealth-monitor.com/features/wm-in-the-classroom/asset-allocation-and-its-role-in-financial-planning/. The views expressed here are those of the authors and do not necessarily represent or reflect the views of Citibank UAE