Importance of Asset Allocation in Investment Management

Suppose you have a week of annual vacation time and decide to take a trip. But first, you'll need to pick where you're going. When it comes to asset management, constructing a portfolio starts with that same thought process. There are endless possibilities of where to go. Think about what this means for portfolio construction. What's the key focus when determining where assets go?

No. Taxes don't determine the overall direction of the portfolio. That's just one part of the overall process.

Way to go! Clearly, asset allocation is going to determine the direction of the portfolio because it provides structure for making other decisions. But think about what steps you'd need to take before leaving on a trip.

No, actually. Liquidity needs are part of the process, but they're not the overall objective.

Before planning a trip, you need to consider factors like your own preferences, your travel companion's preferences, the purpose of the trip, and any travel restrictions. Similar factors also apply in the investment management process, like understanding the investor's own circumstances, objectives, constraints, and preferences. But other variables help determine asset allocation. If you, as the analyst, are also in charge of formulating forecasts, what else should go into asset allocation decisions?

That's right! Capital market inputs, or capital market expectations, should factor into your asset allocation decision. So together with the client's personal factors, you can complete the first step in portfolio construction, which is asset allocation. And not only is it the first step, it's also primarily considered the most important because it determines passive return levels, and actually much more than that. If you put together all investable asset returns across the world, then what's another reason why asset allocation is so important?

No. That's a feedback step after asset allocation is complete.

No, actually. Compliance with the IPS is a feedback step that provides information on any necessary adjustments.

No. The bank credit cycle will help determine the supply of money.

That's not it. Liquidity needs aren't determined by asset allocation; those come from the investor.

That's it! If you combine all investable asset returns, there's only so much return available, so an individual's asset allocation will determine how much of that return is available to investors. That's one other reason it's so important in the investment process.

To summarize: [[summary]]

Tax considerations

Proper asset allocation

The client's liquidity needs

Capital market expectations

The monitoring of prices and markets

Compliance with the investment policy statement

It determines the supply of money

It determines the liquidity needs of individual investors

It determines the aggregate return levels of all investors

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