Asset allocation

The process of deciding in which sorts of assets to make investments and what proportion of total capital available should be allocated to each choice. The task is as relevant to private investors as it is to giant savings institutions. The latter formalize the process rather more, however, often beginning with a top-down approach, which decides both in which asset classes to make investments (shares, bonds, real estate, cash, other classes) and in which geographical areas to invest (North America, Europe, East Asia, emerging markets, for example). Estimates of the likely returns from individual investment choices compared with the target return that the institution seeks will drive the selection process. From this will follow the decision to invest an above-average or below-average proportion of funds in some markets with reference to benchmark weightings that are commercially available.

Asset

For something so fundamental to investment the surprise is that the definition of an asset is so vague. The US accounting standards body has defined it as being "probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events". However, within the context of a company's balance sheet, an asset is also a deferred cost. If a company shows plant and equipment of £1m in its balance sheet, that represents past expenditures which have yet to be written off and which, according to the accruals concept of accounting, will be depreciated as the plant is used up. The test of whether the plant is ultimately an asset or a liability will be whether it generates after-tax revenue greater than its cost. For a company to survive, most plant and equipment must pass that test. But for other items which are carried forward as assets, such as the deferred cost of a pension fund, there is no suggestion that they can bring economic benefits.

More generally, the broad categories of investments within a portfolio - shares, bonds, property - are known as assets. Hence the term asset allocation.