21 November 2014

Multi-asset trading: How to create the right asset allocation mix

As volatility returns to markets, single asset class exposure can be more vulnerable than a diversified, uncorrelated asset mix. Here are some things to consider.

​​​​​​​​​​​​​​​​​​​​​While two adages often applied to investing - don't keep all your eggs in one basket and stick to your knitting – seem to contradict each other, volatile markets often highlight the vulnerability of sticking to a single asset class or instrument.

Traders should always fully understand the instruments they trade, and there is a propensity to stick with an asset class you are well versed in.

However, the successful trader never stops learning and there are a myriad benefits to consider building a multi-asset portfolio, balanced to reflect a unique risk profile and investment goals.​

What does this mean for traders?

Protect against losses, particularly during volatile market conditions. Traders consider asset allocation (mixing a range of uncorrelated asset classes) as a hedging strategy.

According to portfolio theorist Professor William F. Sharpe, the specific mix of different asset classes and weightings to investments within each asset class accounts for 91% of investment performance.

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Finding the right balance between return and risk when allocating assets is seen as key to achieving trading objectives. Photo: Shutterstock

The benefits of a multi-asset portfolio:

  • Diversifies risk – mixing uncorrelated assets spread across a number of classes means that when one asset class in a portfolio decreases in value, another asset class is more likely to outperform, reducing and balancing a portfolio's overall risk profile.
  • Drives returns – as the performance of different asset classes vary over time, so does the return. By selecting a mix of assets, one is able to maximise their portfolio's overall return rate through establishing more than just one revenue stream from it.

Which assets to include?

A diversified, multi-asset portfolio can draw from as many asset classes as a trading platform permits.

These may include:

  • Cash equities
  • Bonds
  • Commercial and residential real estate (including Real Estate Investment Trusts - REITs)
  • Derivatives (futures and options)
  • Investment Trusts
  • Foreign exchange/FX (both spot and options)
  • Commodities (e.g. precious metals like gold and platinum as well as energy)
  • Contracts for Difference (CFDs)
  • Money market instruments

 

How to choose the right asset allocation mix:

There's no correct formula. Allocating the right asset mix depends on each individual's approach to and motivations for investing in capital markets. For example, one may want to consider:

1)    Short/long term goals

2)    Investment timeframe

3)    Risk tolerance

4)    Different instrument types:

  • Active (buying and selling of financial instruments)
  • Passive (securities that automatically track the broader market; e.g. Exchange-Traded Funds/Commodities

5)    Consider a 'style'; how to approach trading:

  • Tactical Asset Allocation (TAA). The portfolio's original strategic asset mix can be changed dynamically in pursuit of short-term profits. The investment time horizon is unconstrained and can be daily, weekly or monthly.
  • Strategic asset allocation. Tends to be less active than TAA

Asset allocating is not just a one-off technique, rather an evolving life-long process of tinkering, tailoring and adjusting in order to seek the desired rewards.​


 

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The value of your investments can go down as well as up.
Losses can exceed deposits on margin products. Please ensure you understand the risks.