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TRANSCRIPT
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Asset Allocation and
Investment Policy
An investment strategy is based on fourdecisions1. What asset classes to consider for investment
2. What normal or policy weights to assign to each eligible class
3. The allowable allocation ranges based on policy weights
4. What specific securities to purchase for the portfolio
85% to 95% of the overall investment return isdue to the first two decisions, not the selectionof individual investments
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Asset Allocation
Strategies
Integrated asset allocation
capital market conditions
investors objectives and constraints
Strategic asset allocationconstant-mix
Tactical asset allocation
mean reversion
inherently contrarian
Insured asset allocation
constant proportion portfolio insurance
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Integrated asset allocation
Capital Market
Conditions (C1)
Prediction
Procedure (C2)
E(R), Risk,
Correlations (C3)
Investors Risk
Tolerance (I3)
Investor Risk
ToleranceFunction (I2)
Investor Assets,
Liab., Net Worth
(I1)
Optimizer (M1)
Investors Asset Mix (M2)
Realized Returns (M3)
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Strategic asset allocation
Used to develop a long-term policy allocation
Example: Portfolio will always rebalance to
revert to a 60% Stock/30% Bond/10% Cashallocation
Practical issues:
Frequency of rebalancing
Reevaluation of the policy allocation
ex. Northeasterns endowment
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Tactical asset allocation
Used to develop short-term strategies to exploit changesin market conditions
Often viewed as a contrarian strategy
Assume asset class performance is mean-reverting
if stocks have performed above average relative to bonds,underweight stocks and overweight bonds for next period
Assume stocks will generate above average returns
overweight stocks!
Practical issues:
Frequency of rebalancing
Constraints on swing component
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Insured asset allocation
Used to develop short-term strategies to exploit changesin investors objectives and constraints
This is a portfolio insurance strategy
Assumes investors become more risk-tolerant as wealth rises
if stocks have performed above average relative to bonds,overweight stocks for next period
Assumes investors become less risk-tolerant as wealth falls
If stocks have performed poorly, underweight in next period
Practical issues:
Frequency of rebalancing
Liquidity
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Which Allocation Strategy is Best?
Define $ invested in stocks (S)
S = m(A - F)
where A = total asset value
F = floor value for assets
m = multiplier
B = $ invested in riskless bonds (=A-S)
Three Strategies (A=100):
Buy and Hold (m=1, F=40)
Constant Mix (m=.6, F=0)
Portfolio Insurance (m=2, F=70)