Modern Portfolio Theory
Modern Portfolio Theory or “MPT”, is a theory of finance that attempts to reduce risk for a given level of expected return by carefully choosing the proportions of various assets and spreading these choices throughout the market. In plain English “don’t put all your eggs in one basket”.
You can achieve a steady rate of return and lower risk by spreading your stock choices across a number of sectors and industries. (See the Global Industry Classification Standard.)
To develop a diversified portfolio that reduces risk and delivers a rate of return greater than the bench mark we use sector rotation to select the different sectors to invest in, and then weight our choices according to our expectations of future performance.
In our SMSF investment strategy course we demonstrate how we diversify our portfolio to reduce our risk and strive to out-perform the benchmark index.
A sector rotation strategy that utilises Exchange Traded Funds (ETFs) provides investors with an optimal way to enhance the performance of their portfolio and increase diversification. If suitable Exchange Traded Funds are not available, high cap stocks that represent their respective sector can be chosen.
Strategic Asset Allocation
A strategic asset mix is designed to capture the benefits of diversification by looking to invest in assets with low correlations to each other. It all about selecting a mix of asset classes.
An investor may build a balance portfolio of say 70% equity and 20% fixed income and 10% property. This portfolio only needs to be rebalanced at times when an individual asset class has had a strong run and the investor decides to change the asset percentage mix because they believe there is a financial benefit to do so.
Tactical Asset Allocation
A tactical asset allocation requires a higher level of skill. Investor attempt to add value by under-weighting or over-weighting particular assets or sectors at a particular time. They seek to sell the under-performers and give weight to the out-performers. This requires some forecasting ability. Options21 uses a tactical assets approach identifying strong sectors within a specific market. We compare global economic regions and their respective markets using the Global Industry Classification Standard Level 1 and Level 2, comparing the relative performance of each grouping within the GICS framework against predefined benchmarks.