Strategies

Quick Answer

Client circumstances move strategic targets; market conditions trigger tactical, temporary shifts back to those targets. Rebalancing sells winners and buys losers to restore strategic weights, and skipping it lets a portfolio's risk profile drift away from the client's original objectives.

Asset allocation is a foundational portfolio management decision. Strategic asset allocation sets the long-term, client-driven baseline mix a portfolio returns to over time. The exam tests two allocation approaches: strategic and tactical.

What Is Strategic Asset Allocation?

Definition: A long-term, baseline allocation of a portfolio across asset classes (stocks, bonds, cash, alternatives), based on the client's investment objectives, risk tolerance, and time horizon.

Represents the "policy portfolio": the default target mix the adviser returns to over time.

Example: 60 percent equities / 30 percent bonds / 10 percent cash for a moderate-growth investor.

Changes only when the client's fundamental circumstances change (for example, nearing retirement, major life event).

Rebalancing brings the portfolio back to strategic targets after market movements cause drift.

Think of it this way: Strategic asset allocation is like setting the thermostat in your house. You choose a target temperature (your allocation) and the system periodically kicks in to bring things back to that level. You are not constantly adjusting; you set a plan and maintain it.

Exam Tip: Gotchas

Strategic allocation is long-term and client-driven. If a question describes changing allocations because the client's goals or risk tolerance changed, that is a strategic allocation adjustment, NOT tactical.

How Does Rebalancing Work?

Rebalancing restores the portfolio to its strategic asset allocation targets after market movements cause drift.

What Triggers a Rebalance?

Trigger: Calendar-based. How it works: Rebalance at fixed intervals (quarterly, semi-annually, annually). Advantage: Simple, predictable.

Trigger: Threshold-based. How it works: Rebalance when any asset class drifts beyond a set percentage (for example, plus or minus 5 percent from target). Advantage: More responsive to market moves.

What Happens When You Rebalance?

Sell overweight positions (winners that have grown beyond target).

Buy underweight positions (losers that have fallen below target).

Enforces a buy low, sell high discipline: selling outperformers, buying underperformers.

Tax implications: Selling appreciated assets triggers capital gains (consider tax-loss harvesting or rebalancing within tax-advantaged accounts).

Transaction costs: Frequent rebalancing increases trading costs.

Failure to rebalance causes style drift: the portfolio's risk profile diverges from the client's original objectives.

Think of it this way: Without rebalancing, a 60/40 stock/bond portfolio can drift to 75/25 after a strong equity run. The portfolio now carries significantly more risk than the client agreed to.

Exam Tip: Gotchas

Style drift occurs when a portfolio deviates from its stated investment style over time (for example, a value fund gradually buying growth stocks, or a mid-cap fund holding large-cap positions). On the exam, style drift is presented as a reason to monitor managers and rebalance.

What Is Tactical Asset Allocation?

Definition: Short-term deviations from the strategic allocation to exploit perceived market opportunities. Sometimes called market timing at the asset-class level.

The adviser temporarily overweights or underweights an asset class based on market outlook.

Requires active judgment about market conditions.

The portfolio returns to strategic targets once the perceived opportunity passes.

Higher turnover and transaction costs than strategic allocation.

How Does a Tactical Shift Play Out?

A client's strategic target is 60 percent equity / 40 percent bonds. The adviser believes stocks are undervalued and temporarily shifts to 70 percent equity / 30 percent bonds. When prices normalize, the adviser returns to the 60/40 target.

Exam Tip: Gotchas

If a question says an adviser "temporarily overweights equities to take advantage of a short-term opportunity," that is tactical allocation. If it says "the allocation changed because the client is 5 years from retirement," that is strategic.

How Do Strategic and Tactical Allocation Compare?

Feature: Time horizon. Strategic allocation: Long-term. Tactical allocation: Short-term.

Feature: Trigger. Strategic allocation: Client circumstances change. Tactical allocation: Market conditions change.

Feature: Approach. Strategic allocation: Set and maintain targets. Tactical allocation: Deviate from targets temporarily.

Feature: Goal. Strategic allocation: Match risk/return to client profile. Tactical allocation: Capture excess returns.

Feature: Turnover. Strategic allocation: Low (rebalancing only). Tactical allocation: Higher (active shifts).

What Should You Check on Exam Day?

Allocation changes triggered by the client's goals, risk tolerance, or timeline are strategic; a temporary shift to chase a market view is tactical.

Tactical allocation always returns to the strategic targets once the perceived opportunity passes.

Rebalancing sells overweight winners and buys underweight losers to restore strategic targets, a buy-low, sell-high discipline.

Threshold-based rebalancing triggers when an asset class drifts beyond a set band (for example, plus or minus 5 percent from target); calendar-based rebalancing triggers at fixed intervals.

Rebalancing can trigger capital gains on appreciated positions; tax-loss harvesting or rebalancing inside tax-advantaged accounts can offset that.

Failing to rebalance causes style drift, where the portfolio's risk profile diverges from the client's original objectives.