There are three distinct classes of asset allocation. Namely; long term asset allocation, active asset allocation and portfolio insurance.
1. Long term asset allocation: Long term asset allocation is also called "policy asset allocation" or "strategic asset allocation". Here the investor is concerned with the evaluation of the needs of the investment plan. And also an assessment of the appropriate asset mix, which would best meet the requirements of the plan. Basically, the investor is looking for the best compromise between need for stability and a need for performance. And further, to find a best fit asset mix to accomplish this in the long term.
To summarize, with long term asset allocation the investor's objective is to shape the risk profile of a portfolio to meet the long-term needs of the investment plan. Here the investor needs to balance the "aversion to risk" with "the need for performance or return". This is a passive management process.
2. Active asset allocation: Active asset allocation is also called "tactical asset allocation" or "dynamic asset allocation". Here the investor's aim is to improve portfolio performance by responding to opportunities arising from the changing patterns of the securities market. In short, the investor would be changing the asset mix of the portfolio to accomplish this, with funds flowing from one asset class to another within the portfolio.
The investor's objective in tactical asset allocation would be to shift the asset mix of the portfolio from time to time, to respond to the changing patterns of opportunity in the market. This is obviously an active management process, and implies a "buy low, sell high" strategy.
3. Portfolio insurance: Portfolio insurance is also an active asset allocation strategy. Here the investor's aim in not to respond to the opportunities in the market, but to obtain protection against adverse market action. The synthetic put is the best example of implementing portfolio insurance.
The objective of portfolio insurance is to protect against unacceptable portfolio performance or adverse market action. Further it can also be used to reshape the distribution of a portfolio (i.e. to change its asset mix) and its likely return. This is a "sell low, buy high" strategy.
Our discussion would now center on the management of tactical asset allocation. As even passive investors have to adopt it from time to time.