Portfolio Management
Unit – III
Session No. 27
Topic: Implementing the Strategic Asset Allocation
Session Plan
• Recap the previous session
• Summarizing and Q & A
Implementing the Strategic Asset Allocation
• Strategic asset allocation is part of the planning step in portfolio management.
I. Implementation Choices:
– Passive investing.
– Active investing.
– Semi-active investing or enhanced indexing.
– Some combination of the above.
II. Currency Risk Management Decisions
III. Rebalancing to the Strategic Asset Allocation
Implementing the Strategic Asset Allocation
• Passive (Inactive) position can be implemented through:
• A tracking portfolio of cash market securities—whether self-managed, a
separately managed account, an exchange-traded fund, or a mutual fund—
designed to replicate the returns to a broad investable index representing that
asset class.
• A derivatives-based portfolio consisting of a cash position plus a long position
in a swap in which the returns to an index representing that asset class is
received.
• A derivatives-based portfolio consisting of a cash position plus a long position
in index futures for the asset class.
Implementing the Strategic Asset Allocation
• Active investing can be implemented through:
• A portfolio of cash market securities that reflects the investor’s perceived
special insights and skill and that also makes no attempt to track any asset-class
index’s performance.
• A derivatives-based position (such as cash plus a long swap) to provide
commodity-like exposure to the asset class plus a market-neutral long–short
position to reflect active investment ideas.
Implementing the Strategic Asset Allocation
• Semi-active investing can be implemented through (among other
methods):
• A tracking portfolio of cash market securities that permits some under- or
overweighting of securities relative to the asset class index but with controlled
tracking risk.
• A derivatives-based position in the asset class plus controlled active risk in the
cash position (such as actively managing its duration).
Implementing the Strategic Asset Allocation
• Currency Risk Management Decisions
• Whether using passive or active investing, if any money is allocated to a
nondomestic asset class, the investor’s portfolio will be exposed to currency
risk—the volatility of the home-currency value of nondomestic assets that is
related to fluctuations in exchange rates.
• Therefore, the investor must decide what part of the net exposures to
currencies to hedge (eliminate).
• The hedging decision affects the expected return and volatility characteristics
of the portfolio.
• The asset allocation and hedging decisions can be optimized jointly.
Implementing the Strategic Asset Allocation
• Rebalancing to the Strategic Asset Allocation
• Rebalancing mean adjusting the actual portfolio to the strategic asset allocation
because asset price changes have moved portfolio weights away from the target
weights beyond tolerance limits.
• Rebalancing may be done on a calendar basis (such as quarterly) or on a
percentage of portfolio basis.
• Example for Percentage of Portfolio basis:
Implementing the Strategic Asset Allocation
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Why managers need a familiarity on implementation?
What is Passive investing? Give example.
How active investing can be implemented?
Why semi-active investing used?
What are the factors that affect implementation decisions?
What is the role of hedging in risk management?
What is the delegation of function to currency overlay manger?
Why rebalancing is used in Strategic Asset Allocation? How it is used?