Portfolio Management Unit – III Session No. 27 Topic: Implementing the Strategic Asset Allocation Unit – III Session No. 27 Topic: Implementing the Strategic Asset Allocation

Session Plan Recap the previous session Summarizing and Q & A

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

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? Implementing the Strategic Asset Allocation