Asset Allocation/Introduction

Issues influencing Asset allocation

Volatility

Investments vary in the extent of their potential losses or gains. Stocks are prone to greater rises and falls than would be experienced in cash deposit investments. The level of loss an individual is willing to accept will influence the spread of asset type. Equally too little risk may also be unacceptable to an individual who wishes to benefit from the potential increase in a rising market

Term of Investment

The volatility that is experienced over short periods of time may not be as significant to an investor who is investing over several years. The overall trend of a market becomes more important. Investments with a greater measure of volatility may be more prudent over longer periods than safer investments that carry a greater risk of not only a lower relative return to other investments, but also the risk of loss through inflation.

Currency Risk

Investments outside the domestic market or currency zone of an investor will be subject to additional risk through movements in exchange rates. Markets investing in similar assets may perform closely, but changes in the value of their respective currencies can mean that from the reference point of the investor they have performed very differently.

Correlation

Diversifying asset allocation through investing in different funds that are in the same market or are heavily influenced by similar factors (such as is the case with many stock markets) is unlikely to be an efficient means of diversifying risk. Assets that perform closely over a period of time are said to be closely correlated. Investments that do not perform in line with each other may be negatively correlated (one is likely to rise on the fall of another through changing business cycles or patterns of demand) or, where there is little relationship, be said to be uncorrelated. Some bond markets have a measure of reverse correlation to stocks and generally real estate investments are uncorrelated to the performance of stocks.