would agree that the most important decision an investor makes is the asset allocation decision. Often, investors distinguish between two types of asset allocation decisions: a strategic asset allocation and a tactical asset allocation. A useful way to tell the two types apart is by focusing on the time horizon. Usually, investors regard a strategic asset allocation as a portfolio designed to reflect their long-term investment objectives (10 years or longer), while a tactical asset allocation reflects shorter-term investment objectives (perhaps as short as the next month). The focus of this chapter is on strategic asset allocation. First, we'll review the key decision points in strategic asset allocation. Second, we'll review the shortcomings with the standard approaches to asset allocation. Third, we'll show how an equilibrium approach can resolve many of these issues. Finally, we'll use the discussion of an equilibrium approach and the key decision points to provide a guide to three subsequent chapters. DECISION POINTS IN STRATEGIC ASSET ALLOCATION Practitioners often regard asset allocation analysis with a mixture of awe and trepidation. Both reactions, as it turns out, are a result of the computational effort that seems to be required to derive optimal portfolios. Computational effort notwithstanding, a useful way to think about asset allocation is to identify the key decisions necessary to do it successfully. From our perspective, there are five distinct decision points in strategic asset allocation: (1) the bond/equity split, (2) the level of diversification across publicly traded equity and fixed income securities, (3) the level of currency hedging, (4) the level and structure of active risk, and (5) the allocation to alternative asset classes such as hedge funds, private equity, or real estate. The impact of each of these decisions has important consequences for the risk and return characteristics of an investor's ultimate portfolio. The split between fixed income and equities generally turns out to be the most important driver of the total level of portfolio risk. Investors who are not comfortable with high risk levels in their portfolios would naturally be expected to have higher fixed income allocations, and vice versa. This decision is often usefully ana-