This is a term that is used to define the activity of spreading investment over different assets in a portfolio to provide diversification and balance risk. This can be a personal portfolio of investments, selecting a mix of equity, bonds, and cash, for example, or the more complex composition of an investment fund.
The manager of an investment fund will build allocation around the investment objective and policy of the fund; if the fund is an equity fund, then they will allocate most, if not all, of the fund to equity. In contrast, the manager of a multi-asset managed fund may allocate dynamically into different asset classes to ensure the fund remains within a certain profile of risk or volatility.
Active fund managers are able to dynamically alter their asset allocation to reflect their economic outlook, underweighting their portfolio in sectors, industries or regions where they believe the outlook isn’t as strong, or overweighting where they believe there are opportunities they can benefit from. Managers will also use their allocation to balance risk.
Understanding how a portfolio of investments is allocated helps you understand how it may behave; a portfolio allocated into bonds and cash will have very different characteristics to a portfolio heavily allocated into equities.