Monday, December 29, 2008


(1).Definition .
Asset allocation is the process of deciding how to distribute an investor’s wealth among different countries and asset classes for investment purposes.
This process will be guided by the investor’s policy statement which will specify;
  • The types of risks the investor is willing to take; and
  • His or her investment goals and constraints.
    For an individual investor, needs change over the investor’s life cycle. The policy statement will be related to an investor’s;
  • Age;
  • Financial status;
  • Future plans; and
  • Needs.
(2).Phases of wealth assimilation-investor’s life cycle.

The investor’s life cycle stage can have an impact on his or her risk and return preferences.
a) Accumulation phase
Individuals are in the early-to-middle years of their working careers. The features of this phase are;
Net worth small relative to liabilities;
Priorities will include:
  • Saving for fairly immediate needs;
  • Life and disability insurances; and
  • Investments for future financial independence;
    Very long time horizon and growing income stream and hence can undertake more high Return, high-risk investment.
a) Consolidation phase.Individuals are in the mid-to-late career stage. The features of this phase are:
-Income exceeds expenses;
-Investment portfolio is accumulating (including equity and retirement programs):
Shorter time to retirement leads to some risk control and capital preservation and hence high capital gain investments are balanced with some lower risk assets.
a) Spending phase,
This generally starts with retirement. The features are:
-Individuals are financially independent;
-No earned income and therefore reliant on capital;
-Focus on assets with relatively secure values and high income streams.
a) Gifting phase,
This generally coincides with the spending phase and the features are:
-Assets exceed needs:
-Risk & return preferences are unchanged but the purpose of the investments changes.
The above analysis is oversimplified. The basic personality that each investor brings to his stage in the life cycle greatly influences where he falls on the risk and return continuum.
(3).Goal setting.

All individual investor must be investing to achieve a goal, either tangible or intangible. These goals can be categorized as follows,
Near-term high priority goals, for example, a house down-payment-
Low risk investment chosen.
Long term high priority goals-More aggressive investment approaches but diversified to avoid unnecessary risk.Lower priority goals -Speculative kinds of investmentsEntrepreneurial or money-making goals-All investor in one stock (often own company or employee)
(4).The policy statement.

The process of formulating a policy statement serves several purposes:
(a).It helps investors understand their own needs, objectives & investment constraints by learning about financial markets & the risks of investing.
(b).It will assist the advisor or portfolio manager in managing client’s funds.
(c).It crates a standard by which the performance of the portfolio manager can be judged.

The construction of the statement is mainly the responsibility of the investor. The investor has to be in a position where he or she can articulate & communicate his or her needs & goals to the portfolio manager.
(5).Investment objectives.

These are the investors investment goals expressed in terms of both risk & return. A careful analysis of the investors risk tolerance should precede any discussion of return objectives & this will be influenced by the following:
(a).The inventors psychological make up current insurance coverage & cash reserves.
(b).The investor’s family situation number of dependents & age.
(c).The investor’s current net worth & expectation of future income & salary.
The return objective may be stated as a general goal or in terms of & absolute or relative percentage return.
Capital preservation
Minimize the risk of loss appropriate objective for very risk-averse investors.
Capital appreciation
Want the portfolio to grow in real terms over time. Very aggressive strategy. Appropriate objective for investors willing to take on risk to meet their objective.
Current income
Minimize income generation rather than capital gins. Low risk strategy appropriate for investors who want to suppliant their earnings.
Total return
Increase portfolio value by both capital gains & reinvesting current income. Risk exposure lies between that of the current income & capital appreciation strategies.
(6).Investment constraints.

The policy statement, in addition to stating the investors risk & return objectives, will specify certain constraints which will have an impact on the investment plan.
In outline the constraints are as follows
(a).Liquidity needs.
1. Emergency cash.
2. Near term goal spending.
3. Income taxes.
4. Investment flexibility.
(b).Time horizon.
The discussion of an investor’s life cycle phases highlighted the time horizon as an investment constraint. In addition, an investor’s time horizon, liquidity needs and ability to handle risk are all related.
(c).Tax concerns.
In general terms the objective is to,
  • Defer tax
  • Avoid tax or
  • Pay tax at the lowest rate possible
    It is important to appreciate the different tax treatment of income versus capital gains.
(d).Legal and regulatory factors.
There can be divided into three categories
(a).investment specific regulations.
(b).Fiduciary duties.
(c).Trading laws.
(e).Unique needs and preferences.
There are certain investments which an investor may want to include or exclude form his or here portfolio for personal or social consciousness reasons.
(f).The portfolio construction process.The portfolio management process consists of the following steps
  1. Identification and evaluation of the investor’s objectives, preferences and constraints as a basis for constructing the investor’s policy statement.
  2. Formulation of appropriate investment strategies (asset allocation) & hence the selection of optimal combinations of financial & real assets.
  3. Monitoring of market conditions, relative asset values, and the investors circumstances.
  4. Adjustments of the portfolio as are appropriate to reflect significant changes in any of the relevant variables.

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