How does an active trading work?
Using alternatives to generate risk-adjusted returns
Active multi-asset investing may provide investors with diversification across different asset class investments, markets and sectors. It may also be beneficial for managing your risk and potentially generate better returns and better match your financial investment goals.
As such it requires taking a total portfolio approach - from investing in traditional asset classes such as equities and bonds to derivatives, active foreign exchange (FX) strategies and other liquid alternatives.
A fully robust multi-asset investment approach should also invest across different dimensions, including investment styles, risk exposures and timeframes. Additionally it needs to be flexible to respond to market conditions and your requirements. However, each investor will have their own preferences when it comes to multi-asset class investing and there is rarely a ‘one-size-fits-all’ solution; diversification is key to spread and manage portfolio risk more effectively.
There are many types of assets that an investor can choose to include in an asset allocation strategy, which include: Commodities (e.g. precious metals like gold and platinum as well as energy); Commercial and residential real estate (including Real Estate Investment Trusts (REITs)); Cash; Derivatives (futures and options); Contracts for Difference (CFDs); Investment Trusts; and, FX (both spot and options).
Active trading is the active buying and selling of financial instruments, with the investor deciding when to move in and out of positions, in line with their trading strategy.
An active investor continuously monitors their holdings and seeks to proactively exploit market movements to their advantage (profiting from alpha exposure). This is in contrast to passive investing, which employs exchange traded funds (ETFs), exchange traded commodities (ETCs) and index trackers to gain beta market exposure.
Strategic versus Tactical?
There are several types of asset allocation strategies based on investment goals, risk tolerances, time horizons and diversification including strategic and tactical. You may consider an active investment strategy based on tactical asset allocation, strategic asset allocation – or a combination of the two.
- Tactical Asset Allocation
Tactical Asset Allocation (TAA) is an active strategy that enables investors to create and generate extra value by taking advantage of certain market situations to exploit short-term opportunities. It is a multi-pronged approach that does not focus solely on yield (i.e. income) and balances the trade off between yield and risk.
This strategy, like Global Tactical Asset Allocation (GTAA), focuses on general movements in the market rather than on performance of individual securities. It is intended to boost investment returns by being overweight or underweight asset classes based on their performance over a relatively short time frame (e.g. one, three or six months).
What may be considered as a particular benefit of TAA is that it may be used to ensure a balance of risk across various sectors and markets globally in order to help smoothe the investment performance at times of market stress. However, a caveat here is that one needs to be aware that there is a risk that taking a tactical approach may not always enhance performance.
- Strategic Asset Allocation
The primary objective of strategic asset allocation by contrast is to create an asset mix that will provide the optimal balance between expected risk and return for a long-term investment horizon. Pension funds typically have a longer time horizon but this is not necessarily set in stone. Such investors pursuing this type of strategy don't seem to be interested in shifting their asset allocations around based on changing market or economic conditions.
As a strategy it tends to be less active than TAA. For example: An investor could decide to allocate 60% in equities, 20% in bonds, 15% in property and leave 5% in cash and review their strategic asset allocation strategy over a one- to three-year time period.
With a TAA approach this can be reviewed more quickly if market conditions change
(i.e. in a bear market) where an investor might decide to go underweight in equities and reduce their exposure to 40% from 60% and rebalance their portfolio across other asset classes.
- Core Satellite Asset Allocation
This strategy is a mixture of passive and active investing. The strategy employs low-cost passive instruments such as ETFs, ETCs or index trackers to gain access to the beta performance of large, traditional markets – such as the FTSE or S&P 500 indices.
For the active element of the strategy, investments that reflect your investment style and in which you have a high degree of conviction that the investment will return a positive market-beating (e.g. alpha) performance. In a multi-asset portfolio, the active element could consist of the broad range of asset classes available – from commercial property to cash equities to Futures contracts.
Remember: There are no guarantees to the performance of any active multi-asset investment approach. But it may be rewarding. As with all stockmarket investments they bring with them an element of risk.