Lesson 7 of 8 · All lessons in this module
- The investment policy statement: why and what
- Risk objectives and risk tolerance: ability vs willingnessVideo lesson
- Return objectives and the required returnVideo lesson
- Constraints: liquidity, horizon, tax, legal and unique circumstancesVideo lesson
- Asset classes and the strategic asset allocation
- Integrated case: IPS thresholds, client exclusions and the efficient frontier
- From SAA to portfolio: risk budgeting, TAA, selection and rebalancing
- ESG considerations in planning and construction
Lesson 7 of 8 · 15 min
From SAA to portfolio: risk budgeting, TAA, selection and rebalancing
After the SAA, the manager splits the risk budget among strategic allocation, tactical deviations and security selection, chooses active or passive management per asset class, and controls drift with a rebalancing policy.
In short
- Risk budgeting: the total risk is set in the IPS; the manager subdivides it among the SAA, tactical asset allocation (TAA) and security selection, each with risk limits.
- TAA is a deliberate, short-term deviation from policy weights based on near-term return forecasts. Its contribution = .
- Security selection tries to beat the asset class benchmark. It is a zero-sum game before costs; the average active manager underperforms net of costs. Value added depends on skill and on how inefficient the market is.
- For illiquid classes (unlisted real estate, infrastructure) active selection is unavoidable: no cheap diversified exposure exists.
- Market moves cause drift; a rebalancing policy with corridors (bandwidths) restores policy weights. Newer developments: ETFs and robo-advice, and risk parity (weights by risk contribution).
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