Asset allocation and portfolio management Mohammad qasem aljahmani Accounting master Omar abed alrahman hayajneh Finance master.
Before making your investment make sure :1. Level of return2. Risk3. Liquidity4. Transaction costs
Asset Allocation The process of determining optimalallocations for the broad categories of assets(such as Stocks, Bonds, Cash, Real Estate, ...) that suit your investment time horizon and risk tolerance. OR what proportion of a portfolio should be placed in the relevant asset classes
The importance of asset allocation1. different asset classes react to changing market conditions in different ways.2. appropriate asset allocation can help you maintain confidence through economic ups and downs and even increase your potential for better returns over time.3. To enhance return and reduce risk.4. Establishing a well diversified portfolio may allow you to avoid the risks associated with putting all the eggs in one basket.5. Each asset class has different levels of return as well as risk and therefore will behave and react differently to a given market situationNote :Keep in mind that neither diversification nor asset allocation ensures a profit or guarantees against loss.
Why resort to asset allocation ?1. To diversify the risk (as don’t expect equity & bond market to fall at the same time).2. Since one does not know before hand what economic situation would be tomorrow , but it’s logical to invest in more than one asset class.
How to do asset allocation ?1. Divide the investment between the high and low risk and minimize the risk .2. Based on long and short term goals of the investor and decide on the asset mix that will fetch the best desired returns.3. Sticking to your allocation pattern would discipline you to buy low.4. Reducing the equity component .
asset allocation decisions involves 3 important variables1. Time frame2. Risk tolerance3. Personal circumstances
What are asset classes?It is often useful to group similar investmentstogether into asset classes.what makes different investments similar?
DisadvantagesCategories can be useful, but are not perfect. A dangerinherent in asset allocation is assuming that assetcategories or asset classifications create homogeneousgroups of securities.Assuming securities are more correlated (or subject to thesame risks) within a category than between categories canbe faulty.Another problem is what Ennis (2009) refers to as“category proliferation and ambiguity.” It is always possibleto further differentiate between categories, and somesecurities seem to be so unique that they defy easycategorization, going into an “alternative” category.
Some considerations in determining the right asset allocationIn determining the right asset allocationstrategy for you, consider your:1.Unique financial situation2.Comfort with investment risk and flexibility3.Retirement goals and time frame
some asset allocation strategies that blend stock, bond, and short-term investments to achieve different levels of risk and return potential.
Definition of Portfolio Management The art and science of making decisionsabout investment mix and policy, matchinginvestments to objectives, asset allocation forindividuals and institutions, and balancing riskagainst performance. Portfolio management is all about strengths,weaknesses, opportunities and threats in thechoice of debt vs. equity, domestic vs.international, growth vs. safety, and many othertradeoffs encountered in the attempt tomaximize return at a given appetite for risk.
Forms of portfolio management1- Passive management : simply tracks a market index, commonly referred to as indexing or index investing.2- Active management : involves a single manager, co- managers, or a team of managers who attempt to beat the market return by actively managing a funds portfolio through investment decisions based on research and decisions on individual holdings. Closed- end funds are generally actively managed.
Purpose of Portfolio ManagementPortfolio management primarily involvesreducing risk rather than increasing return Consider two $10,000 investments: 1) Earns 10% per year for each of ten years (low risk) 2) Earns 9%, -11%, 10%, 8%, 12%, 46%, 8%, 20%, -12%, and 10% in the ten years, respectively (high risk)
Low Risk vs. High Risk Investments $30,000 $25,937 $23,642 $20,000 Low Risk High $10,000$10,000 Risk $092 94 96 98 00 02
Low Risk vs. High Risk Investments (cont’d)1) Earns 10% per year for each of ten years (low risk) Terminal value is $25,9372) Earns 9%, -11%, 10%, 8%, 12%, 46%, 8%, 20%, - 12%, and 10% in the ten years, respectively (high risk) Terminal value is $23,642The lower the dispersion of returns, the greater the terminal value of equal investments
The Portfolio Manager’s JobBegins with a statement of investment policy, which outlines: 1- Return requirements 2- Investor’s risk tolerance 3- Constraints under which the portfolio must operate A person cannot be an effective portfolio manager without a solid grounding in the basic principles of finance
The Six Steps of Portfolio Management1) Learn the basic principles of finance2) Set portfolio objectives3) Formulate an investment strategy4) Have a game plan for portfolio revision5) Evaluate performance6) Protect the portfolio when appropriate
Conclusion:The best asset allocation give us the best portfolio management
References• Ennis, Richard, “Parsimonious Asset Allocation,” Financial Analysts Journal, May/June 2009.• Brian J. Jacobsen, “An Asset Allocation Primer” Wells Fargo Funds Management, LLC, February 05, 2010