Portfolio Management

Asset allocation is the process of dividing investments among different asset categories to optimize the risk-return profile based on individual goals, risk tolerance, and time horizon. Strategic Asset Allocation: Age-Based Allocation: • Traditional Rule: Equity % = 100 - Age • Modern Approach: Equity % = 110/120 - Age (due to increased life expectancy) • Example: 30-year-old investor = 70-80% equity, 20-30% debt • Adjust based on risk tolerance and goals Life-Cycle Based Allocation: 1. Accumulation Phase (20s-40s): • High equity allocation (70-90%) • Focus on growth and wealth creation • Can afford higher volatility • Long investment horizon 2. Consolidation Phase (40s-50s): • Moderate equity allocation (50-70%) • Balance between growth and stability • Start reducing risk gradually • Preserve accumulated wealth 3. Distribution Phase (60s+): • Conservative allocation (30-50% equity) • Focus on capital preservation and income • Lower volatility tolerance • Liquidity requirements increase Goal-Based Asset Allocation: Short-term Goals (< 3 years): • Conservative allocation: 10-20% equity, 80-90% debt • Focus on capital preservation • High liquidity requirements • Examples: Emergency fund, vacation, car purchase Medium-term Goals (3-7 years): • Moderate allocation: 40-60% equity, 40-60% debt • Balance between growth and stability • Moderate risk tolerance • Examples: House down payment, child's education Long-term Goals (> 7 years): • Aggressive allocation: 70-90% equity, 10-30% debt • Focus on wealth creation • Can handle volatility • Examples: Retirement, child's higher education Dynamic Asset Allocation: Market Condition Based: • Increase equity allocation during bear markets • Reduce equity allocation during bull markets • Contrarian approach to market cycles • Requires market timing skills Valuation-Based Allocation: • Use market valuation metrics (P/E, P/B ratios) • Increase equity when markets are undervalued • Reduce equity when markets are overvalued • Systematic approach to market timing Volatility-Based Allocation: • Increase equity allocation when volatility is low • Reduce equity allocation when volatility is high • Use VIX or similar volatility measures • Risk parity approach Asset Classes for Allocation: 1. Equity Assets: • Large-cap stocks/funds (stability) • Mid-cap stocks/funds (growth) • Small-cap stocks/funds (high growth potential) • International equity (diversification) • Sector-specific investments 2. Fixed Income Assets: • Government bonds (safety) • Corporate bonds (higher yield) • Fixed deposits (guaranteed returns) • Debt mutual funds (professional management) • PPF, EPF (tax benefits) 3. Alternative Assets: • Real estate (inflation hedge) • Gold (portfolio diversifier) • Commodities (inflation protection) • REITs (real estate exposure without direct ownership) • Cryptocurrency (high-risk, high-reward) Geographic Diversification: • Domestic vs international allocation • Developed vs emerging markets • Currency diversification benefits • Consider regulatory and tax implications Rebalancing Strategies: 1. Calendar Rebalancing: • Rebalance at fixed intervals (quarterly/annually) • Simple and systematic approach • May not capture market opportunities • Good for disciplined investors 2. Threshold Rebalancing: • Rebalance when allocation deviates by certain percentage • More responsive to market movements • Requires regular monitoring • Can be combined with calendar approach 3. Volatility-Based Rebalancing: • Rebalance more frequently during volatile periods • Less frequent during stable periods • Adaptive approach to market conditions • More complex to implement Rebalancing Considerations: • Transaction costs and taxes • Market timing implications • Use new investments for rebalancing • Consider tax-loss harvesting opportunities Common Asset Allocation Mistakes: • Not having a clear allocation strategy • Emotional allocation changes during market volatility • Ignoring correlation between asset classes • Over-diversification (diworsification) • Not rebalancing regularly • Ignoring tax implications of rebalancing Modern Portfolio Theory Applications: • Efficient frontier concept • Risk-return optimization • Correlation analysis between assets • Sharpe ratio maximization • Mean reversion assumptions