This ability may allow them to invest a smaller percentage of their total portfolio in
equities and still earn their target rate of return.
Tactical Asset Allocation
Portfolio Revision
At the stage of strategic asset allocation, we determine a target beta and duration for the
total portfolio and decide how the portfolio is allocated among asset classes to achieve
this objective. That is not, however, the end of the matter.
The first complication that arises in managing the risk of the total portfolio is that the
relative weights of the equity and bond portfolio in the total portfolio can change because
of a change in market values. For example, if there is a boom in share prices, the equity
portfolio rises sharply in value, and its weight in the total portfolio also increases. This
immediately changes the average beta of the total portfolio though the investor has not
altered the composition of the portfolio. Similarly, the average duration is also affected.
If he wants to maintain the old beta and duration, he will have to rebalance his portfolio.
Similar problems can arise if interest rates rise causing a sharp drop in the value of the
bond portfolio changing its weight in the total portfolio.
Example 3
Consider the asset allocation of Example 9.2. What happens to the overall beta and
duration if there is a boom in the stock market and equity prices rise by 50%?
Solution
Asset Class Original
Percent
Original
ValueCurrent value Current
percent
Bonds 80 80 80 73
Equities 20 20 30 27
Total 100 100 110 100
The average duration of bonds was 5 years and of equities 30 years. We shall assume
that the average beta of the equities was 1.0. We assume for simplicity that the boom in
share prices has not changed the duration or betas of our equity portfolio.
Original duration = 5 x 80/100 + 30 x 20/100 = 10 Years
Original beta = 0 x 80/100 + 1 x 20/100 = 0.20
Current duration = 5 x 73/100 + 30 x 27/100 = 11.75 years
Current beta = 0 x 73/100 + 1 x 27/100 = 0.27