Asset allocation is a risk-reward strategy that divides an investment portfolio among various asset classes such as equity, fixed income, cash and cash equivalents, real estate, and so on. The theory is that asset allocation helps the investor to lessen the impact of risk their portfolio is exposed to as each asset class has a different correlation to one another.
What are the various asset categories/classes?
Traditionally, there were three main types of investments. However, there are four major asset groups that are generally accepted by financial professionals. This includes:
First, Fixed Income is one of the oldest and most widely used investing strategies available today. Debt securities encompass everything from government and corporate bonds to money market transactions. Debt securities are the primary asset class for these instruments, and investors get regular interest payments until the scheme matures.
Equity, often known as stock, refers to ownership stakes in businesses that are traded publicly. Equity has skyrocketed in popularity during the past decade. There are many different kinds of equity funds, including small-cap, mid-cap, large-cap, large-and-mid-cap, multi-cap, contra, dividend, value, yield, sectoral, targeted, and Equity-linked Savings Schemes (ELSS) funds.
Third, Money Market Instruments (also known as cash and cash equivalents) are securities that are ideal for short-term investment horizons. Liquidity is the main benefit of these products. Cash equivalents are highly liquid instruments that may often be redeemed within 90 days. Investors have quick access to funds held in liquid assets such as bank accounts and money market funds.
The fourth category is Real Estate, which includes things like land, homes, businesses, and factories. What sets these investments apart from others, such as virtual or dematerialized assets, is their physical presence.
How asset allocation works?
Let’s look into the concept of asset allocation using an example. A person named Joey loves sports and invests in sports equipment companies. Joey initially spends all of his money in one ice hockey gear company. Winter ice hockey demand drives this investment. Joey’s investment could suffer if ice hockey suddenly loses popularity or consumer preferences.
Thus, Joey diversifies his portfolio after realizing the pitfalls of investing in one sector. He invests in basketball, soccer, tennis, and swimming equipment firms. Joey decreases his risk by investing in multiple areas and sports.
Joey’s portfolio is no longer based on ice hockey gear demand. Other sports investments give consistency and seasonal growth. Joey decreases the risk of major losses and raises the chance of year-round earnings by diversifying his investments.
Joey diversified his investment portfolio to reduce sector risk. Such scenarios exemplify asset allocation, where investing in multiple assets or sectors reduces risk and creates a more stable and potentially profitable portfolio.
What Is a Fund Manager?
One who manages a fund and is responsible for carrying out the investment strategy and monitoring the portfolio’s transactions. Schemes and portfolios can be managed by one person, two individuals, or more. Even if there are three persons managing the portfolio, he just has to pay the fee associated with a single director. Compensation for fund managers typically consists of a share of AUM and, depending on the terms of the agreement, a share of any profits made.
Role of Fund Manager
Investors should think about diversifying and growing their holdings when selecting a mutual fund. The management of a mutual fund decides on all purchases and sales of holdings in the fund. Because of their experience or the research and analysis they conducted before investing, they have a deep understanding of the markets. In addition, your portfolio receives both active and passive management.
Here are some distinctions between the two administration styles:
With Active Management, the portfolio’s holdings are selected by the fund manager without regard to external factors. All of these people play important roles in determining how a mutual fund’s investments do.
Passive Management is a form of portfolio management in which a certain percentage of the portfolio is constructed using a predetermined index rather than human judgment.
How do fund managers allocate assets?
Fund managers have a robust approach to asset allocation. Investment managers allocate capital among holdings with great care. Competition, market trends, and the previous year’s financial performance are all scrutinized. They use this information in conjunction with their experience to make smart financial choices. Managers of mutual funds think about things like fees and the make-up of their portfolios when calculating investor returns. Key Information Memorandums (KIM) and Scheme Information Documents (SID) include important details for investors. Allocating assets effectively requires a blend of art and science.
Imagine that they are master chefs preparing a delicious meal. They take great effort to combine a variety of flavors in just the right proportions. In a similar vein, portfolio diversification is achieved by having fund managers invest in a wide range of assets, such as stocks, bonds, and cash. In order to select the best ingredients, they study market tendencies, rival businesses, and company results. Fund managers fine-tune asset allocations to balance risk and maximize returns, much like a chef tweaks seasoning to achieve perfect harmony. Investors will be served a meal of financial achievement, with each component carefully considered.
