Strategic asset allocation is long term in nature; hence, the weights are called targets and the portfolio represented by the strategic asset allocation is called the policy portfolio.
Selecting and justifying a strategic asset allocation based on investor objectives and constraints is outlined in the following nine steps:
- Determine investor objectives.
- Determine investor tolerance for risk.
- Determine investor time horizon(s).
- Determine investor constraints.
- Select the asset allocation approach.
- Specify the asset classes.
- Develop potential asset allocations.
- Simulate results of potential asset allocations.
- Repeat Step 7 until the optimal asset allocation is discovered.
Tactical asset allocation (TAA) is an active management strategy that deviates from the strategic asset allocation (SAA) to take advantage of perceived short-term opportunities in the market. TAA introduces additional risk, seeking incremental return, often called alpha.
A multiperiod view of the investment horizon is sometimes referred to as dynamic asset allocation (DAA). DAA recognizes that asset (and liability) performance in one period affects the required rate of return and acceptable level of risk for subsequent periods.
Under passive management, investor insights or expectations do not impact the composition of the portfolio.
In contrast, under active management, the portfolio composition changes when investor insights or expectations change.