Strategic asset allocation

Asset allocation is a process of putting money across asset categories in line with a stated objective — both of those words carry weight in the workbook, and most real portfolios fail on both, having drifted into their shape rather than been assigned one.

Strategic asset allocation is the deliberate version. Work out what return the investor needs to reach their goals, how long they have, and how much risk they can carry, and convert that into a percentage target: 60 per cent equity, 40 per cent debt. That percentage is the strategic asset allocation.

What it is not is a market forecast. Nothing in the calculation asks where equities are going. Change the target because the market looks expensive and you have stopped doing strategic allocation and started doing tactical allocation.

Markets then push the portfolio away from the target, because asset classes do not move together or by the same amount. Rebalancing restores it — selling some of whatever has risen and buying whatever has lagged.

The workbook's illustration: a 50:50 target with Rs 1,000 in each of asset A and asset B. A year later A is up 20 per cent to Rs 1,200 and B is down 5 per cent to Rs 950, a portfolio of Rs 2,150 now split 55.81 : 44.19. Restoring 50:50 means selling Rs 125 of A and buying B.

Read what that transaction is. It sells the asset that went up and buys the asset that went down — buy low, sell high — and it does so mechanically, without the investor ever forming a view on direction. Over many market cycles that is the quiet benefit of the discipline.

A separate rule governs the scheme, not the investor. Where a scheme's holdings deviate from the asset allocation mandated in its SID through a passive breach, SEBI allows 30 business days to rebalance, for all schemes other than index funds and ETFs; overnight funds are outside the requirement.

An investor aged 35 holds Rs 40 lakh at a strategic allocation of 60:40, equity to debt.

The split is now 63.10 : 36.90. A good year in equities has quietly made the portfolio riskier than the investor signed up for — which is the whole problem, because the drift always runs towards risk after a rally and away from it after a crash.

Restoring 60:40 means holding Rs 27.84 lakh in equity, so Rs 1.44 lakh moves from equity into debt.

The costs are real and belong in the same conversation. A switch is a redemption: exit load may apply, and the gain on the Rs 1.44 lakh is taxable — at 20 per cent if the units are short-term equity-oriented, or at 12.5 per cent beyond the Rs 1.25 lakh annual exemption if long-term. Many advisers therefore rebalance using fresh inflows first, directing the next several SIP instalments to debt until the target is restored and no sale is triggered at all.

Chapter 1 (Investment Landscape), section 1.8, defines both allocation approaches and works the rebalancing example above; Chapter 12 (Mutual Fund Scheme Selection) then applies the target to choosing schemes. Expect a question distinguishing strategic from tactical allocation, a rebalancing computation from two asset values, and recall of the 30-business-day scheme rebalancing window.

• The SAA is the target, not the current position. Drift is expected; it is what rebalancing exists to correct.
• It is set from goals, horizon and risk profile — never from a market view. Changing it because equities look expensive is tactical allocation wearing the wrong label.
• Rebalancing forces you to sell the winner. That feels wrong and is the point: it is a mechanical buy-low-sell-high with no forecast in it.
• Rebalancing is also triggered by the investor changing, not only by markets moving — a new goal, a changed income, a shorter horizon.
• Rebalancing costs money. A switch between schemes is a redemption plus a purchase, so exit load, stamp duty and capital gains tax all apply.
• SEBI's 30-business-day window is the scheme's obligation to its own SID, on passive breaches, and has nothing to do with the investor's personal allocation.