Strategies

Asset allocation is the single most important decision in portfolio management. How you divide assets among broad categories matters far more than which individual securities you pick. The exam tests two allocation approaches: strategic and tactical.

Strategic Asset Allocation

Definition: A long-term, baseline allocation of a portfolio across asset classes (stocks, bonds, cash, alternatives), based on the client's investment objectives, risk tolerance, and time horizon.

• Represents the "policy portfolio" - the default target mix the adviser returns to over time
• Example: 60% equities / 30% bonds / 10% cash for a moderate-growth investor
• Changes only when the client's fundamental circumstances change (e.g., nearing retirement, major life event)
• Rebalancing brings the portfolio back to strategic targets after market movements cause drift

Think of it this way: Strategic asset allocation is like setting the thermostat in your house. You choose a target temperature (your allocation) and the system periodically kicks in to bring things back to that level. You are not constantly adjusting; you set a plan and maintain it.

Exam Tip: Gotchas

• Strategic allocation is long-term and client-driven. If a question describes changing allocations because the client's goals or risk tolerance changed, that is a strategic allocation adjustment, NOT tactical.

Rebalancing

Rebalancing restores the portfolio to its strategic asset allocation targets after market movements cause drift.

Rebalancing Triggers

How Rebalancing Works

• Sell overweight positions (winners that have grown beyond target)
• Buy underweight positions (losers that have fallen below target)
• Enforces a buy low, sell high discipline: selling outperformers, buying underperformers
• Tax implications: Selling appreciated assets triggers capital gains (consider tax-loss harvesting or rebalancing within tax-advantaged accounts)
• Transaction costs: Frequent rebalancing increases trading costs
• Failure to rebalance causes style drift - the portfolio's risk profile diverges from the client's original objectives

Think of it this way: Without rebalancing, a 60/40 stock/bond portfolio can drift to 75/25 after a strong equity run. The portfolio now carries significantly more risk than the client agreed to.

Exam Tip: Gotchas

• Style drift occurs when a portfolio deviates from its stated investment style over time (e.g., a value fund gradually buying growth stocks, or a mid-cap fund holding large-cap positions). On the exam, style drift is presented as a reason to monitor managers and rebalance.

Tactical Asset Allocation

Definition: Short-term deviations from the strategic allocation to exploit perceived market opportunities. Sometimes called market timing at the asset-class level.

• The adviser temporarily overweights or underweights an asset class based on market outlook
• Requires active judgment about market conditions
• The portfolio returns to strategic targets once the perceived opportunity passes
• Higher turnover and transaction costs than strategic allocation

How It Works

A client's strategic target is 60% equity / 40% bonds. The adviser believes stocks are undervalued and temporarily shifts to 70% equity / 30% bonds. When prices normalize, the adviser returns to the 60/40 target.

Exam Tip: Gotchas

• If a question says an adviser "temporarily overweights equities to take advantage of a short-term opportunity," that is tactical allocation. If it says "the allocation changed because the client is 5 years from retirement," that is strategic.

Comparison: Strategic vs. Tactical