Explore strategic and tactical asset allocation, rebalancing methods, ESG factors, and more to enhance your investment portfolio construction expertise.
Enhance Your Learning:
Building a solid investment portfolio can feel like constructing a house—there’s a sturdy foundation (like your core holdings), supporting structures (the different asset classes), and finishing touches (the short-term adjustments or niche funds). In previous sections, we explored the basics of asset allocation, diversification, and risk management. Here, we dig a little deeper into some special topics that can help you tailor your portfolios to meet a broader range of client needs and preferences, especially in Canada’s evolving regulatory and market environment.
Asset allocation strategies, rebalancing techniques, dollar-cost averaging, ESG investments, and liability-driven investing each offer unique perspectives and tools. Taken together, they can form a cohesive and versatile toolkit. Let’s explore each in turn, and we’ll throw in some personal stories, real-world anecdotes, and best practices along the way.
Asset allocation strategies often determine most of a portfolio’s long-term returns and risk profile. Frankly, you could have perfect timing or a knack for picking winning securities, but if your portfolio’s overall asset allocation is off, you may still fall short of your client’s goals. Two well-known styles stand out:
Imagine you’re a painter with a particular palette of colors—say, you typically favor certain shades of blue, yellow, and red. You periodically step back and make sure the proportions of these colors remain roughly the same for consistency in your painting. That’s somewhat like strategic asset allocation.
In strategic asset allocation, the mix of assets (like stocks, bonds, and cash equivalents) is based on long-term client goals and risk tolerance. Some real-world examples highlight why this method is so popular:
• A retirement portfolio might hold 60% in equity mutual funds, 35% in bond funds, and 5% in cash or near-cash assets.
• A “balanced” approach might attempt a 50-50 split between equities and fixed income, rebalancing every year.
Rebalancing steps in periodically—maybe once a year, or semi-annually—to restore target weights. Market fluctuations can cause the portfolio to drift from these targets. You’ll likely reference your clients’ investment policy statement (IPS) for that “baseline” mix. Over time, the overall target doesn’t usually change dramatically, unless the client’s life circumstances or objectives drastically shift (like receiving a large inheritance).
Tactical asset allocation is a bit like improvising a jazz solo. There is still structure (like the asset mix in your strategic plan), but the investor or portfolio manager changes it up in response to short-term market conditions or perceived opportunities.
Maybe, well, you see that commodity prices are surging and you suspect inflation is on the way. You might tilt more into commodity-exposed equities or inflation-protected bonds for a while, hopefully capitalizing on those conditions. Next quarter, if it looks like technology stocks are oversold, you might tilt the portfolio in that direction.
• Example: A fund manager might shift a portion from domestic equities to global equities if they believe foreign markets have more upside.
• Another scenario: Reducing bond exposure in anticipation of rising interest rates, and then reintroducing them if rate pressures ease.
Tactical asset allocation works best when guided by a solid understanding of market cycles, macroeconomic indicators, and your client’s risk tolerance. It is, however, more hands-on—and let’s be honest, it involves greater risk that your short-term calls might be off.
Below is a simple Mermaid diagram illustrating how strategic and tactical asset allocation might interact:
flowchart LR
A["Strategic Asset Allocation <br/>Sets Long-Term Targets"] --> B["Portfolio Mix"]
B["Portfolio Mix"] --> C["Periodic Rebalancing <br/>(Strategic)"]
B["Portfolio Mix"] --> D["Short-Term Adjustments <br/>(Tactical)"]
D --> B
Rebalancing is the process of reining in a portfolio that has strayed from its target mix. Over time, different asset classes might surge ahead or lag, causing the original allocations to shift away from your ideal risk/return profile. Two common techniques are:
Calendar rebalancing sets a strict schedule—maybe every six months or every year. You don’t worry about the market noise in between (barring extreme events). On that rebalancing date, you adjust the portfolio back to the target weights. This approach is straightforward and systematic, but you might miss opportunities to rebalance at more advantageous times, especially if markets swing rapidly.
• Example: On January 1 each year, you measure the current portfolio allocation. If the equity allocation is 65% but the target is 60%, you might sell 5% worth of equities and move the proceeds to fixed income or cash.
Threshold rebalancing focuses on deviation from target allocations. If equities were supposed to be 60% of the portfolio but drift above 66% (a 10% threshold), you rebalance right away—even if it’s only March and your scheduled rebalancing date was set for June.
Threshold rebalancing can help lock in gains and limit losses during turbulent times. However, it can also generate more frequent transactions (and potentially more costs), so you want to consider transaction fees, taxes, and other logistical factors.
Dollar-cost averaging (DCA) is a technique where you invest a fixed amount at regular intervals, regardless of what the market is doing at that moment. It’s like shopping for groceries every week—you don’t hold off entirely because milk or bread prices might fluctuate; you buy what you need consistently. Over time, you purchase more shares when prices are lower and fewer shares when prices are higher.
• Example: Contribute $500 on the 15th of every month into a mutual fund. Over a year, sometimes you’ll catch the fund at a high price, sometimes at a low price, and sometimes in between.
Clients often appreciate the simplicity and psychological benefit of this approach: they don’t have to find the perfect time to invest. It also helps keep emotions in check, which is huge when markets get choppy.
Do your clients care about sustainable business practices, carbon emissions reduction, or fair labor policies? ESG investing is gaining traction worldwide, including right here in Canada. ESG factors can influence the mutual fund selection process:
• Environmental: Pollution, resource depletion, climate change policies.
• Social: Employee relations, diversity, community impact.
• Governance: Board structure, executive compensation, shareholder rights.
ESG investing is about aligning portfolios with investors’ personal values and, at times, capturing potential financial upsides. Some research suggests that well-managed companies with strong ESG factors can exhibit resilience in volatile markets. Of course, results vary, and it’s not guaranteed ESG funds will always outperform non-ESG peers. But the evolving Canadian regulatory environment encourages more disclosure around sustainability—for instance, the Canadian Securities Administrators (CSA) have introduced guidelines on ESG-related disclosures, and CIRO provides guidance regarding suitability for clients seeking ethical or sustainable investments.
It’s also worth noting that ESG rating agencies (like MSCI ESG Research Tools) use different methodologies to evaluate companies. So if you or your clients are serious about ESG, you’ll want to check multiple sources before deciding that a particular fund is up to standard.
While it might sound super technical, liability-driven investing (LDI) is simply an approach that aligns a portfolio’s assets with future liabilities. The concept is especially popular in pension fund management. If you know you will need to pay pension obligations to retired employees in 10, 15, or 20 years, it makes sense to structure your investments so that the cash flows match (or closely mirror) those future outlays.
• Example: A corporate pension plan expects to pay $200 million in retirement benefits in about 15 years. It might choose long-term bonds that mature around that time, locking in interest rates so it can match assets to liabilities.
• Another example: Individuals with large, predictable future expenses (like paying for a child’s education or a mortgage balloon payment) might prefer LDI-type strategies.
In Canada, large institutional investors (like the Canada Pension Plan Investment Board) widely use forms of LDI to manage extensive long-term liabilities. While LDI may be less common in everyday retail investing, some elements—like planning for future cash needs—can still be applied to personal portfolios or structured mutual fund recommendations. The main idea: if you know you’ve got a big expense in the future, you want to be fairly certain the assets you choose will be there to cover it.
Sometimes a story can help clarify these concepts. I once had a client who was adamant about never putting more than 50% in equities because she’d seen her father lose nearly everything during a severe market downturn decades ago. We set a strategic asset allocation of 50% equities (across different mutual funds) and 50% fixed income. We used threshold rebalancing, with a 5% deviation threshold. There was a moment when equities shot up in a raging bull market, and her holdings went up to around 58%. We used that as our cue to rebalance, captured some profit, and she felt far less anxiety about potential future downturns.
In another scenario, a younger client asked about short-term tactical tilts because he was convinced that renewable energy stocks were about to surge. We allocated a small percentage for tactical tilting into a global environmental solutions equity fund. This approach didn’t entirely pan out as he expected—renewable stocks had a rough year—but because it was a limited portion of the portfolio, it didn’t derail his overall financial goals.
In Canada, the process of constructing portfolios must meet any relevant demands and regulations administered by the Canadian Securities Administrators (CSA) and supervised by the Canadian Investment Regulatory Organization (CIRO). After the January 1, 2023, amalgamation of the MFDA and IIROC, CIRO is the one-stop self-regulatory organization responsible for overseeing both investment dealers and mutual fund dealers.
Key guidelines under CIRO revolve around ensuring client suitability. If your client is big on ESG, for instance, it’s essential to document these preferences and select funds consistent with those goals. If your client’s risk tolerance is conservative, you’ll need to show that the portfolio’s asset allocation, rebalancing strategy, and short-term tactical moves stay aligned with that risk profile.
Don’t forget about the CIPF (Canadian Investor Protection Fund), which remains the sole investor protection fund in Canada. While CIPF doesn’t directly influence portfolio construction, it does help protect client assets in case a CIRO-member firm becomes insolvent, offering peace of mind for many investors.
• Clearly define client objectives: Ensure your selections—strategic or tactical—flow from well-documented goals and risk tolerance.
• Communicate thoroughly about rebalancing: Some clients might balk at selling “winners.” Education on why it’s crucial helps them embrace the discipline.
• Be mindful of trading costs: Frequent threshold rebalancing might add up. Try to offset these costs or plan trading carefully.
• Watch out for behavioral biases: Overconfidence can creep in, especially with tactical asset allocation. Dollar-cost averaging can help remove some emotional pitfalls, but keep clients informed about how markets fluctuate.
• ESG data inconsistencies: One rating agency might praise a company’s practices, while another criticizes them for reasons that are not easily comparable. Do your due diligence.
Investors and advisors in Canada have more tools than ever for portfolio construction. Robo-advisor platforms often incorporate DCA, digital rebalancing, and even some ESG screening functionalities. Meanwhile, many mutual fund databases offer advanced filters for factors like carbon impact or social responsibility. Some well-known resources:
• ESG ratings databases (e.g., MSCI ESG, Sustainalytics)
• Online rebalancing calculators (banking and fintech apps)
• Institutional resources from the Canada Pension Plan Investment Board on liability-driven approaches
• CIRO’s official website (https://www.ciro.ca) for regulatory updates and guidance
The following Mermaid diagram offers a quick visual overview of how these additional portfolio construction topics interconnect:
flowchart TB
A["Long-Term Goals <br/>(Strategic Asset Allocation)"] --> B["Periodic Rebalancing"]
B --> C["Tactical Adjustments"]
B --> D["Dollar-Cost Averaging <br/>(DCA)"]
A --> E["Liability-Driven Investing <br/>(LDI)"]
A --> F["ESG <br/>Considerations"]
• CIRO (https://www.ciro.ca) – For current Canadian regulatory information and updates
• Canadian Securities Administrators – ESG-related disclosure guidelines
• Canada Pension Plan Investment Board – Examples of large-scale liability-driven investing
• Gibson, Roger C. “Asset Allocation: Balancing Financial Risk.”
• “Investing in the Age of Climate Change” – Institutional research sources
• MSCI ESG Research Tools – For ESG data and ratings
Feel free to explore these resources to get an even deeper understanding of advanced allocation strategies, rebalancing methods, ESG considerations, and LDI frameworks.