Investment Strategies
Agenda
Diversification
Asset Allocation
Active Investment Strategies
Rebalancing & Review
Diversification
⚫ Expected return from Individual securities is associated with some
degree of risk
⚫ Most investors cannot tolerate short-term fluctuations in their
securities
⚫ Diversification is a risk-management technique that mixes a wide
variety of investments within a portfolio in order to minimize the
impact that any one security will have on the overall performance of
the portfolio.
⚫ Effect of diversification is to lower the risk of the portfolio
Benefits of Diversification
⚫ Portfolio Risk = Market Risk (systematic) + Unique Risk( unsystematic) of
portfolio
⚫ Market Risk of a portfolio = weighted arithmetic average of the market
risk of the individual securities constituting the portfolio
e.g., if a certain amount is invested in three stocks A, B & C having
Betas of 1.2, 0.9 & 1.3 in the proportion 0.5, 0.3 & 0.2 respectively,
the market risk of the portfolio will be:
0.5 (1.2) + 0.3 (0.9) + 0.2 (1.3) = 1.13
⚫ Unique Risk of a portfolio, however, behaves differently. Unique Risk
tends to decline as the portfolio becomes more diversified.
⚫ In a diversified portfolio, unique risks of different securities tend to
offset each other. Hence, overall unique risk of the portfolio diminishes,
and rather rapidly.
⚫ Diversification helps an investor in eliminating (or diversifying away)
unique risk.
Diversification and Risk
Unique Risk
Total
Risk
Market Risk
5 10 15 20
No. of securities in portfolio
Levels of Diversification
⚫ Security Level
⚫ Invest in more than one stock, say a combination of a few
blue chip and a few aggressive stocks
⚫ Industry Level
⚫ Ensure that the stocks selected are spread across various
industries / sectors
⚫ Asset Level
⚫ Diversify across asset classes, e.g., stocks, mutual funds,
bonds, money market, bank deposits (this approach is known
as Asset Allocation)
Agenda
Diversification
Asset Allocation
Active Investment Strategies
Rebalancing & Review
What is Asset Allocation?
Asset allocation refers to the strategy of dividing your total
investment portfolio among various asset classes, such as
stocks, bonds and money market securities. Essentially,
asset allocation is an organized and effective method of
diversification
Investments : Key Determinants
⚫ The most important determinant of portfolio return is asset
allocation .
Security Selection
4.6%
Market Timing 1.8%
Other Factors 2.1%
Asset
Allocation
91.5%
Source: Brinson, Singer & Beebower
Asset allocation
Asset Allocation encompasses the following:
⚫ Selection of the asset classes
⚫ Proper blending of these asset classes in a portfolio
⚫ Managing the asset mix over time.
Asset Allocation Principles
⚫ Risk and return are related
⚫ Risk depends on the length of time one holds the
investment
⚫ Rupee Cost Averaging can reduce the risks of investing
⚫ Risks that an investor can take depends on the investor’s
capacity to take risks and his attitude to take risks.
Asset Allocation drivers
Asset allocation must take into account 2 factors:
⚫ Time horizon: the number of years you have to invest
⚫ Risk tolerance: your ability or willingness to endure short-
term declines in the value of your investments as you
pursue your long-term investment goal
Strategic Asset Allocation
⚫ Strategic asset allocation is a method that establishes and
adheres to what is called a 'base policy mix'. This is a
proportional mix of assets based on expected rates of
return for each asset class
⚫ E.g. If stocks have historically returned 10% per annum and
bonds have returned 5% per annum, a mix of 50% stocks
and 50% bonds would be expected to return 7.5% per year
Tactical Asset Allocation
⚫ In the short term, the investor may occasionally engage in
tactical deviations from the mix in order to capitalize on
unusual or exceptional investment opportunities
⚫ This flexibility adds a component of market timing to the
portfolio, allowing investors to participate in economic
conditions that are more favourable for the performance
of one asset class than for others
Tactical Asset Allocation
⚫ Tactical asset allocation can be described as a moderately
active strategy, since the overall strategic asset mix is
returned to when desired short-term profits are achieved
⚫ This demands some discipline from the investor or
portfolio manager, as he or she must first be able to
recognize when short-term opportunities have run their
course, and then rebalance the portfolio to the long-term
asset position
Dynamic Asset Allocation
⚫ Dynamic asset allocation is when the mix of assets is
constantly adjusted as markets rise and fall and the
economy strengthens and weakens
⚫ E.g. In a dynamic portfolio, if the stock market is showing
weakness, stocks are sold in anticipation of further
decreases in stock values, and if the market is strong,
stocks are purchased in anticipation of continued market
gains
Which Asset Allocation style is best ?
⚫ Asset allocation can be an active process in varying degrees or
strictly passive in nature
⚫ Choice of a precise asset allocation strategy or a combination of
different strategies depends on one’s goals, age and risk
tolerance
⚫ These are only general guidelines on how investors may use
asset allocation as a part of their core strategies
⚫ Allocation approaches involving anticipating and reacting to
market movements require a great deal of expertise and talent
in using particular tools for timing these movements.
⚫ Accurately timing the market is next to impossible, so make sure
your strategy isn't too vulnerable to unforeseeable errors
Risk Profile of Investor
Risk profiling is a well-established scientific and robust way of profiling
risk among investors. Research has established clear relationships
between demographic attributes of investors and their investment risk
appetite.
⚫ Conservative : This profile is suitable for investors who prefer to
preserve capital and do not intend to taking any exposure to high risk
investments.
⚫ Moderate: This profile is suitable for investors who are willing to take
an exposure of 30% to 50% in higher risk investments like equity
related products.
⚫ Aggressive : This profile is suitable for aggressive investors who are
willing to invest major part of their portfolio in equity related products
and clearly are well informed about the potential downside that could
arise in case of a sharp fall in the markets.
Agenda
Diversification
Asset Allocation
Active Investment Strategies
Rebalancing & Review
Active Investment Strategies
⚫ Market Timing
⚫ Sector Rotation
⚫ Security selection
⚫ Use of a specialized concept, Investment style like value style &
Growth Style
Growth Style
Growth Investing focus on companies that will experience faster than
average growth as measured by revenues, earnings or cash flow.
Growth oriented companies more likely to reinvest profits in
expansion projects or acquisitions, rather than use them to pay out as
dividends to shareholders.
⚫ Growth Investing requires a higher tolerance of risk as well as a longer
time horizon. Growth Investing do better than overall market when
stocks prices in general are rising, while underperforming the market
as stock prices fall.
Value Style
The goal of value investing is to find proverbial diamonds in the rough;
that is, companies whose stock prices don’t necessarily reflect their
fundamental worth.
Such securities may be stock in public companies that trade at
discounts to book value or tangible book value, have high dividend
yield, have low price to earning multiples or have low price to book
ratio
Value Investing focus on perceived safety than growth, often investing
in mature companies that are primarily using their earnings to pay
dividends.
Agenda
Diversification
Asset Allocation
Active Investment Strategies
Rebalancing & Review
Rebalancing
• Portfolio rebalancing is the action of bringing a portfolio of Investments
that have deviated from targeted asset allocation back into its original
allocation.
• if an investor's investment strategy or tolerance for risk has changed, he
or she can use rebalancing to readjust the weightings of each security or
asset class in the portfolio to fulfill a newly devised asset allocation
• Rebalancing will help you stick to your investing plan
regardless of what the market does.
Basic policies applicable in Rebalancing
Periodic/ Calendar rebalancing of the portfolio is indicative of the
frequency of rebalancing. This could be quarterly, half yearly or any
other period. :
⚫ Buy & Hold : Here the policies are essentially that of buy and hold,
ignoring the market value of the assets.
⚫ Constant Mix policy : This involves maintaining the mix of asset
allocation of various asset classes in accordance to what is its target
asset allocation.
⚫ Portfolio Insurance policy : In this rebalancing policy, a floor level is
decided then asset allocation is structured accordingly. Objective of
this policy, in case risky assets value fall below floor price then
whole portfolio shift to risk free asset. In case of rise in value of
risky asset class then the Portfolio manager under this policy would
reduce the exposure to risky asset class in order to ensure that the
value remains intact.
Financial planning review
⚫ The financial planner should establish a client file and a
system for periodic review and revision.
⚫The financial planner to monitor performance of investments,
changes in tax laws & regulations (the general economic
environment) and also evaluate new financial products for
possible inclusion.
⚫Financial planner to regularly evaluate the plan with respect
to any changes in the client’s situation.
Need for financial planning review
Regular reviews are necessary for :
⚫ Changes in personal circumstances- Plans may need to be
revised for reasons such as loss of a job, addition of a new
family member and so on.
⚫ Changes in the external environment- Changes in regulations,
economic and market conditions may warrant changes in the
financial plans
⚫ Product related factors- To find out if the product
recommended to the client is still applicable to his needs.
Benchmarking Performance
⚫ Setting a performance benchmark helps track progress made
towards the goal. The type of benchmarks to be used is
important.
⚫ These are important indicators for both the client and the
financial planner. These indicators trigger off action that may
be required
⚫ The review process will help in identification of areas which
need changes to be made.
⚫ Situation may require focus on a particular goal to shift or
abandonment of goals.
⚫ A new plan should then be presented to the client,
incorporating such changes.
Thank You
