Asset Allocation
Overview
Asset allocation refers to process of determining how much of a portfolio should be invested in each of its various
asset types, or classes. The most commonly used asset classes are equities and fixed income, and most of the
first basic asset allocation strategies focused on allocating between these two.
As time progressed, investors began to broaden the asset allocation frameworks. First, investors subdivided
fixed income and equities into subcategories. Second, investor began to look to other
alternative asset classes for further diversication and return enhancement.
For the purposes of this page, we will take the broadest definitions and discuss both strategies and security types as
asset classes.
Asset Classes
Goals of Asset Allocation
At a basic level, the goals of asset allocation are the same as portfolio construction of any portfolio, to create an
optimal portfolio
in terms of risk/reward tradeoff. However, one could use the techniques of portfolio construction to choose from
a broad array of assets, without having to sort them into asset categories first.
One of the primary goals of an asset allocation process is put constraints on the investment process. Many clients
of investment managers want to prevent that manager from taking too much risk, or investing in certain assets
with which the client is not comfortable.
A second benefit of utilizing an asset allocation framework is that it splits the portfolio problem into smaller
easier to manage sub-problems. That is, the manager can then consider the dollar amount invested in each asset
class independently of the decision of which assets to choose in each class.
This in turn creates the possibility of delegating the managing of each class to a manager who is a specialist in that
particular class.
Asset Allocation Process
