The investment industry is full of technical jargon that may be unfamiliar if you are not a professional investor. In this article, we define some of the most commonly used terms that you may hear when you talk to a portfolio manager, or when you read about managing your investments.
Security selection refers to the process of choosing individual investments (stocks and bonds) in an investment fund.
Active and Passive Security Selection
Generally, there are two dominant approaches to security selection: active and passive. In active security selection, on or more portfolio managers and analysts research individual stocks and bonds, and decide on what to buy and sell in the portfolio. In passive security selection, the decisions on what to buy and sell inside the fund are based on pre-determined rules. These rules are sometimes called the "index methodology". Because there is much less day to day research and human-intervention required in passive security selection, passive funds typically have much lower fees than their active counterparts.
An asset class is a group of securities that have similar risk and return characteristics, and behave similarly under changing macro-economic environments. Asset classes fall into four main categories: cash and cash equivalents, equities (or stocks), fixed income (or bonds), and alternatives.
Equities can be further categorized based on factors such as geographical location, size, industry and sectors. Fixed income securities can further be categorized based on geographical location, creditworthiness of the issuers, time to maturity, and other factors.
Assets that do not fit in the cash, equities or fixed income categories are frequently called Alternatives. Alternatives assets can include hedge funds, commodities, infrastructure and real estate.
Asset allocation refers to the process to decide the split between major asset classes such as stocks, bonds, and real estate, and geographies such as North America, in one's investment portfolio
Asset allocation refers to the proportionate size of assets inside an investment portfolio, and is one of the most important aspects of any investment plan. The idea behind asset allocation is to diversify your investment portfolio among different asset classes to achieve the highest possible return for a given level of risk. Research shows that a significant portion of a portfolio's risk and return can be explained by its asset allocation decisions.
Strategic Asset Allocation
Strategic asset allocation is an investment strategy that sets the investor's asset allocation based on their timeframe, risk appetite, and long-term considerations. The strategic asset allocation does not usually change with short-term changes in the markets.
Tactical Asset Allocation
Tactical asset allocation is an investment strategy that adjusts an investor's asset allocation based on market and economic events and trends. The starting point of the tactical asset allocation is the strategic allocation. The allocations are decreased or increased to each asset class to reflect the views of the investment team. Tactical asset allocation results in more frequent changes to an investment portfolio compared to a portfolio that employs strategic asset allocation only.