Overview

Asset allocation strategies are probably the most important determining factor to achieve better risk-adjusted return through diversification across major and minor asset classes or strategies: according to a study by Gary Brinson, Randolph Hood and Gilbert Beebower, asset allocation strategies is responsible for over 90% of variations in portfolio performance. Major asset classes include US equity (stock), international and emerging market equities, real estate, fixed income (bond and cash), commodities, hybrid (such as convertibles), private equity and/or hedging funds (such as long short, market neutral, convertible arbitrage etc.).

Asset allocation strategies could be static or tactical. Static (or called strategic) means a fixed target allocation among assets (with periodical (or other ways) rebalancing). Well known static asset allocations include those so called 'lazy' portfolios. Tactical means changing the allocation mix (such as overweight on US equity or underweight on bonds) based on current outlook of the asset classes.

Recent painful market crash also reminded investors that it is perhaps not adequate to just simply buy and hold, even over a well diversified assets. In fact, in 2008, even a fairly diversified asset allocation portfolio such as Roger Gibson's (see ValidFi's model lazy portfolios, for example) lost well over 20%. In contrast, a portfolio with various dynamic strategies over diversified assets protected portfolio capital much better. ValidFi offers severail multi-strategy based portfolios and users are encouraged to study them.

Here is the list of asset allocation strategies

Tutorials

• Basic overview: Understanding Asset Allocation from Franklin Templeton
• SEC basic overview: Beginners' Guide to Asset Allocation, Diversification, and Rebalancing
• More comprehensive: Asset Allocation: Balancing Financial Risk by Roger Gibson
• Vanguard's tactical asset allocation: an excellent paper, especially on tactical signals/models and the portfolio management (overweight/underweight).
• Multi-strategy portfolios: Core-Satellite Investing by EDHEC-Risk
• TIAA-CREF Tutorials on YouTube: Three parts, this is part2 by Brett Hammond, Chief Investment Strategist, TIAA-CREF

Categories of Asset Allocation Strategies

• Static (Lazy) asset allocation strategies:

  These are the strategies whose allocation percentages for assets are fixed. Periodical or some rebalancing strategies are used to balance the portfolios back to the original target allocation. Numerous well known investors published books and articles proposing model portfolios. Paul Farell at MarketWatch.com has maintained a list of such portfolios which he called 'lazy' portfolios. These portfolios usually employ index funds or ETFs to get exposure to various asset classes. They have low maintenance cost and are very tax efficient. ValidFi's lazy portfolios could be accessed here. Since every investor has different risk tolerance and return expectation, ValidFi's Mean Variance Optimization or Black-Litterman's asset allocation (BLAA) tool could be used to adjust the allocation percentages based on a lazy portfolio of your choice to accommodate your risk/return profile (i.e. investors start from the asset classes in a lazy portfolio they choose and BLAA will automatically output the appropriate allocation utilizing those asset classes only).

• Momentum Based Strategies (across asset classes):

  Based on a well known study by Eugene Fama and others, momentum strategies are one of the four major strategies which could materially determine the portfolio's return and risk. ValidFi maintains some of robust and well known momentum strategies for the asset rotation. They have proved from time to time the best strategies. Examples of momentum based strategies include GS Pure FundX and S&P Diversified Trend Indicators.

• Value Based Strategies:

  Again, one of the four Fama-French factors which determine portfolio returns. Fed Models and Relative valuation based asset rotation strategies are some of value based strategies.

• Dynamic Strategies:

  Dynamic strategies adjust asset selection and allocation based on certain quantitative criteria. Momentum and Valuation based strategies are dynamic strategies. ValidFi collects other dynamic strategies including
  • Timing based asset allocation: multiple assets are timed based on certain technical indicators such as 10 month simple moving average. Endowment Model is such a strategy.
  • Alpha//Sharpe Dynamics: it selects asset allocation funds (such as those flexible funds) based on the best alpha or Sharpe in the past periods such as one year.
  • RAA based Dynamic Strategies: the asset allocation is dynamically changed based on the realtime asset allocation analysis (RAA) of top asset allocation funds.
  • BL (Black-Litterman) based Dynamic Strategies: the asset allocation analyzed from RAA is further fed to BL algorithm to achieve a better stable asset allocation along the time.

• Target date life cycle asset allocation strategies:

  These strategies are the low cost versions of adjusting risk factors based on investors' ages or time to approach retirement. They are one size fit all solutions. ValidFi maintains a list of target date life cycle funds. We plan to offer a more detailed analysis and asset allocation tool to construct your own target date based portfolios.

• Multiple Strategies:

  In addition to multiple asset diversifications, institutions have employed multiple uncorrelated strategies to further diversify risk away. A popular method is Core Satellite portfolio in which a portfolio is divided into a core portfolio and a satellite portfolio. The core portfolio is a diversified static portfolio fully calibrated based on investor's risk/return profile while the satellite portfolio employs tactical (dynamic) strategies such as those based on valuation or momentum. ValidFi has a strategy called Simple Core Satellite to show how to utilize its hierarchical portfolio capability to easily construct such a multiple strategy portfolio.