Strategy vs. Tactic: Asset Allocation Models in IPS Development

by Patrick Oberhaensli, on May 25, 2020 12:04:00 PM

The fundamental step before actively taking part in financial investments, is developing a customised Investment Policy Statement (IPS) along with the guidance from the brokerage portfolio manager.  The key components of an IPS overview are further detailed in my article regarding kick-starting the investment journey.  Once the investor has laid the groundwork and specified adequate basis for their IPS, the next step is to consider the asset allocation process.  In this article, I will examine the strategic approach to asset allocation in regards to IPS development.


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Overview: Strategic Asset Allocation

The Strategic Asset Allocation (SAA) process can begin on the basis of objectives and constraints: the aim of the investor is to establish a diversified long-term allocation of the different asset classes that satisfies their individual requirements. The SAA will necessitate the estimation of a multitude of parameters – the more asset classes considered, the higher the number of parameters – this consists of, among other aspects, the long-term returns and risks elements. It’s important to keep in mind that a certain level of subjectivity cannot be avoided as well as the “optimisation” method used. The shorter-term perspectives in regards to returns are not relevant in this situation, the Tactical Asset Allocation (TAA) will take account of those perspectives. In order to achieve sufficient coverage, the investor implements defined tactical ranges around the Strategic Asset Allocation.

Passive vs. Active

As the global markets move there will be deviations from the specified SAA. In order to address this, a rebalancing technique needs to be adopted – these terms will have to have been chosen in advance. The decision to outsource the management of certain assets usually via mandates or funds is key and has major organisational consequences. The investments can be categorised as either passive or active nature. “Passive” means that the portfolio will follow the benchmark while “active” means that the portfolio manager aims to outperform the benchmark.

Investment Discipline

One of the main purposes of the implementation of the IPS is to support investment discipline. When the U.S. large cap equities reached their bottom in March 2009, the investor applying a classic SAA would have been buying stocks then (and previously) – and certainly not selling. A long-term rally started at that point (and it still lasts in 2019) which highlights a drawback from the SAA approach. In the case of an up-trend, the investor would be instinctively selling stock too early. To ensure, to a certain degree, that the complete investment process is properly implemented, an effective Internal Control System (ICS) needs to be in place and should be referenced in the investor's IPS.

The limitations of an SAA model can only be partly compensated with a TAA – the TAA allowing to overweight equities when an up-trend has been identified. Moreover, it becomes less relevant when, for example, illiquid assets and/or short positions are (should) be used. Therefore, an approach that goes beyond purely directional exposure (in more liquid assets) is more often adapted. This explicitly covers investments that are not directional and can be obtained through options or relative value positions. The latter is composed of two instruments that are strongly related (correlated), one being long and the other short at an adapted level.  The correlation values are according to the expectation of prices aligning or in a contrary situation seeing their difference increase. There are of course other possibilities such as the factor-based method which also distance themselves from an SAA approach.


In conclusion, establishing an IPS is essential in order to develop a controlled investment process. It doesn’t matter what type of investor we’re talking about nor what tools will be used to implement the investments. It is key, at the same time, to understand that the classic approach (referring to the SAA model) needs a modern upgrade in order to increase (ideally, maximising) its utility for investor today.

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Topic:Online Trading PlatformAsset AllocationIPSRisk ManagementInvestment Strategy
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