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Archive for the ‘Asset Allocation’ Category

Video Lectures of Portfolio Management CFP

Posted by Prashant Shah on May 5, 2017

Posted in Asset Allocation, CFP, Investment Planning | 1 Comment »

Asset Allocation for CFP

Posted by Prashant Shah on July 29, 2013

Asset allocation is an investment strategy that aims to balance risk and reward by apportioning a portfolio’s assets according to an individual’s goals, risk tolerance and investment horizon.

Asset allocation is the process of deciding how to distribute an investor’s wealth among different countries and asset classes for investment purposes. An asset class is comprised of securities that have similar characteristics, attributes, and risk/return relationships.

The asset allocation decision is not an isolated choice; rather, it is a component of a portfolio management process.

Types of Asset Allocation

Strategic Asset Allocation

  • ™A portfolio strategy that involves periodically rebalancing the portfolio in order to maintain a long-term goal for asset allocation
  • At the inception of the portfolio, a “base policy mix” is established based on expected returns
  • Because the value of assets can change given market conditions, the portfolio constantly needs to be re-adjusted to meet the policy

Tactical Asset Allocation:

  • An active management portfolio strategy that rebalances the percentage of assets held in various categories in order to take advantage of market pricing anomalies or strong market sectors
  • This strategy allows portfolio managers to create extra value by taking advantage of certain situations in the marketplace
  • It is moderately active strategy

Insured Asset Allocation:

  • Insured asset allocation assumes that expected market returns and risks are constant over time, while the investor’s objectives and constraints change as his or her wealth position changes.
  • For example, rising portfolio values increase the investor’s wealth and consequently his or her ability to handle risk, which means the investor can increase his or her exposure to risky assets.
  • Declines in the portfolio’s value lower the investor’s wealth, consequently decreasing his or her ability to handle risk, which means the portfolio’s exposure to risky assets must decline.
  • Often, insured asset allocation involves only two assets, such as common stocks and T-bills.
  • As stock prices rise, the asset allocation increases the stock component.
  • As stock prices fall, the stock component of the mix falls while the T-bill component increases.
  • This is opposite of what would happen under tactical asset allocation.
  • Insured asset allocation is like the integrated approach without the feedback loop on the capital market side
  • It is sometimes called a constant proportion strategy because of the shifts that occur as wealth changes.


Rebalancing is bringing your portfolio back to your original asset allocation mix. This is necessary because over time some of your investments may become out of alignment with your investment goals. You’ll find that some of your investments will grow faster than others. By rebalancing, you’ll ensure that your portfolio does not overemphasize one or more asset categories, and you’ll return your portfolio to a comfortable level of risk.

There are basically three different ways you can rebalance your portfolio:

  • You can sell off investments from over-weighted asset categories and use the proceeds to purchase      investments for under-weighted asset categories.
  • You can purchase new investments for under-weighted asset categories.
  • If you are making continuous contributions to the portfolio, you can alter your contributions so that more investments go to under-weighted asset categories until your portfolio is back into balance.

Investment with a Portfolio and Rebalancing

Assume a requirement of 1500000 after 10 years. Investment is made in equity and debt in a ratio of 75:25. Investment is made at the beginning of the period. Find amount to be invested in equity and debt each. Rate of return on equity 11% and debt 8%.


Assume investment amount   of 1000. Hence 750 will be invested in equity and 250 will be invested in   debt.


As both equity and debt   grow at their own rate, find FV of both in isolation

Equity  : PMT(bgn)=750          N=10                i/y=11              FV:13921

Debt    : PMT(bgn)=250          N=10                i/y=8                FV:3911

Total value of the   portfolio: 17832

If investment of 1000   accumulates 17832, how much to invest for 1500000?

Cross multiplication:   1500000*1000/17832 = 84120 (approx)

Equity investment=63090

Debt investment=21030

Portfolio Rebalancing

Assume in the above case if proportion changes after 5 years to 50:50, the amount of investment in each component will be


Assume investment amount   of 1000. Hence 750 will be invested in equity and 250 will be invested in   debt.


As both equity and debt   grow at their own rate, find FV of both in isolation

Equity  : PMT(bgn)=750          N=5                  i/y=11              FV:5185

Debt    : PMT(bgn)=250          N=5                  i/y=8                FV:1584

Total value of the   portfolio after 5 years: 6769

Now the portfolio will be   divided in 50:50


Equity  : PV=3385        PMT(bgn)=500            N=5                  i/y=11              FV:9160

Debt    : PV=3385        PMT(bgn)=500            N=5                  i/y=8                FV:8141

Hence the total value of   portfolio = 17301

Cross multiplication:   1500000*1000/17301 =86700 (annual   investment)


FPSB Questions

Illustration   -1
A   buisnessman wants to achieve the goal of marriage of his daughter after 10   years. The funds required would be Rs. 25 lakh at then costs. He wants to   invest monthly for the goal. You suggest an asset allocation strategy where   he should invest monthly in equity and debt in ratio 65:35 for 9 years, and   shift the entire accumulated amount in these funds to liquid fund in the last   year. If the returns expected from equity, debt and liquid funds in this   period are 12% p.a., 9% p.a. and 5% p.a., respectively, what approximate   amount per month is required to be allocated to equity and debt schemes?
Illustration   -2
Your   client Mr A. has his Rs. 50 lakh portfolio in three asset classes as on 1st   April 2009 comprised of Equity and Debt each in 35 % allocation with the rest   of the portfolio invested in Gold ETF. Over the period upto 1st January 2013,   Gold has given a total return of 90 % in the portfolio whereas equity and   debt have returned 11% and 15%, respectively. You rebalance the portfolio   today and change its allocation to 60% in equity with the other two classes   equally sharing the balance. What should be the transfer of money amongst   asset classes?
Illustration   -3
Your client starts   investing immediately for 10 years annually Rs. 60,000 in the ratio of 80:20   in equity and debt products. You expect return from equity and debt to be   11.75% p.a. and 8.25% p.a. during this period. To protect the wealth, he   rebalances the portfolio in 40:60 ratio of equity and debt after 10 years and   invests in the same ratio annually Rs. 60,000 for the next 5 years. The   return expected from equity and debt in this period subsides to 9% p.a. and   7% p.a., respectively. What rate of return is expected on his total   investments? How would this return fare when seen from average inflation of   6% during the entire period?
Illustration   -4
Your client started   investing Rs. 12,000 per month a year ago in an asset allocation of 30:70 in   equity and debt to achieve a goal in 6 years from now by accumulating Rs. 10   lakh. You realize that he would be requiring Rs. 15 lakh for the same goal.   You expect equity and debt to give returns of 11.75% p.a. and 8.25% p.a.,   respectively in the entire period of investment. You assess changing asset   allocation to 65:35 in equity and debt by investing Rs. 2,000 additional per   month to see how closer he can reach to his goal. You find that ______.

Posted in Asset Allocation, CFP, Investment Planning | 9 Comments »