1. Define IPS: Capture the investor requirements and constraints.
2. Determine the strategic asset allocation:
a. Define the investable asset classes for the portfolio and gather historical data on their risk, return and correlation.
b. Combine the IPS and the risk/return profile of various asset classes derived from above step, to determine a strategic asset allocation. Up to this step, investment decisions are entirely passive i.e. returns are primarily generated by investing in asset class indices.
3. Tactical asset allocation:
a. This is the first step of active management.
b. Determine whether there are any short-term opportunities that warrant a deviation from the strategic asset allocation.
c. For example, a top-down analysis shows that given the economic cycle, commodities might outperform. Based on this premise, you overweight the commodity asset class.
4. Security selection:
a. This is second step of active management where particular securities are selected.
b. Identify the relatively strong securities within the favored asset class.
c. For example, in your analysis you decide to go overweight on the base metals securities.
Sign up to get more!