How a fund allocates its assets is determined by the amount of risk it wishes to take and there is nothing to say that it will not change its allocation in the future, writes Una McCaffrey.

Having a few thousand euros to stash away in the investment product of your choice is not a bad position to be in, provided the money has been made through legal means and with the full knowledge of the taxman.

Once these small hurdles have been crossed, it is simply a matter of selecting a home for the cash - or rather, giving your cash to the financial experts so they can select a home for it - and let the asset-allocation process begin.

Asset allocation is a fancy name for the simple process of deciding how a given investment product invests the money available to it.

There are four main asset classes to choose from - equities, cash, bonds and property - with most retail funds selecting a combination of some or all of the four. The nature of that combination at a given time is what separates one fund's performance from the others.

It all sounds straightforward enough until it becomes apparent that how a fund allocates its assets today could change next week, or next month, or may not change at all, depending on how the market looks to the managers in charge.

Even within the various allocations, things can be transformed with one or two deals - selling out of Elan and into Bank of Ireland, for example, could turn the same 70 per cent equity weighting into a very different creature and make a big difference to a fund's performance.

Mr Pat Lardner, head of institutional business with Bank of Ireland Asset Management (BIAM), says asset allocation is basically about risk, taking account of the reality that different asset classes will display varying levels of volatility, liquidity and growth at different times and, therefore, produce different kinds of return.

This means if a fund is guaranteeing the protection of an investor's capital, for example, it will tend to invest mostly in safer assets such as Government bonds. As funds move up the scale, they are more likely to be balanced between the different asset classes. At the riskier end, equities, the class that has historically been both most volatile and most profitable, will usually be the primary concentration.

"The starting point is always what the client wants," says Mr Pat Woods, investment director (Ireland) for Standard Life.

Mr Woods describes how each fund begins with a blank sheet in asset allocation terms and then applies a few general principles.

"Regardless of what type of fund it is, it's going to have some equity exposure," he says.

"We start from the premise that an investment over five years is going to be better off in an equity-type vehicle, for example. For people who want volatility to be dampened down a bit, you might design a balanced fund and put property and bonds in there. Or else you would construct a sort of secure fund, where the provider provides a smoothing mechanism that irons out the returns."

This latter model, known as the with-profits fund, has become increasingly popular in recent times, with Irish retail investors putting €600 million into such vehicles in 2001.

Mr Woods recommends that such investments should be made over a long term, such as 10 years, so that the investment house has the chance to provide a capital guarantee at a lower cost than if the investment was over a shorter term.

With less to pay for a guarantee, more money is free for buying equities - in Standard Life's case, that translates into 88 per cent of the fund's assets.

Moving into higher-risk territory, investors are likely to come across sector-specific or area-specific products, such as technology funds or US equity funds. Such products provide no capital guarantees and, therefore, have no need for "safe" investments to provide room for smoothing.

According to Mr Woods, products such as these can often be more volatile than the indices they follow because they hold a concentrated selection of stocks chosen with the aim of beating the index in question.

In this way, the potential for instability and risk become more pronounced. But if the stock selection bet pays off, it will be worth it.

"What tends to happen is that you have your core holdings in the larger stocks that make up the larger part of the index. You'll always have some holding in those because it's too risky to be out of them."

In the US equity case, such stocks would include Microsoft and IBM, while on the Irish Stock Exchange, pharmaceutical group Elan and the Irish banks would fit the bill.

This stock selection will usually pay some heed to the importance of various sectors within an index so, for example, an equity fund following an index that is 10 per cent comprised of technology companies will, in theory, place about a 10th of its money in the tech sector.

Even within that, there is still more chance of hair-splitting however, as managers buy large chunks in one stock for the fund and smaller holdings in another. This process, known as "weighting", is where financial institutions are really given the opportunity to prove their investment prowess.

At all times, different investment houses will tend to look at the market in a slightly different way, with the result that the same significant market movement may not impact on everyone in the same manner. An example of this came earlier this year when stocks in Elan took a massive tumble on the Irish exchange. Many domestic investment houses saw their returns fall substantially as a result, mainly because Elan represented 22 per cent of the entire ISEQ, it was natural to have a holding therein.

Headlines were subsequently made by BIAM where, it was revealed, funds had held very little Elan exposure and came out relatively unscathed. Standard Life was among the injured parties, as was AIB.

BIAM's Mr Lardner, while refusing to comment on individual stock selections, says his company does not pay a lot of attention to what other investment houses are doing. "We tend to place a lot more emphasis on what the individual companies are telling us," he says.

At Irish Life Investment Managers, head of asset allocation Mr Eugene Kiernan says that he knows a lot more about what other houses are doing now than he did before Elan took its hit. In the general sense, "everybody ploughs their own furrow", says Mr Kiernan. Mr Woods agrees: "You must be following the crowd but trying to beat the crowd."