second investment course – november 2005
Post on 30-Dec-2015
35 Views
Preview:
DESCRIPTION
TRANSCRIPT
2 - 1
Second Investment Course – November 2005
Topic Two:
Asset Allocation: Decisions & Strategies
2 - 2
The Asset Allocation Decision
A basic decision that every investor must make is how to distribute his or her investable funds amongst the various asset classes available in the marketplace:
Stocks (e.g., Domestic, Global, Large Cap, Small Cap, Value, Growth) Fixed-Income (e.g., Government, Investment Grade, High Yield) Cash Equivalents (e.g., T-bills, CDs, Commercial Paper) Alternative Assets (e.g., Private Equity, Hedge Funds) Real Estate (e.g., Residential, Commercial) Collectibles (e.g., Art, Antiques)
The Strategic (or Benchmark) allocation is the proportion of wealth the investor decides to place in each of these asset classes. It is sometimes also referred to as the investor’s long-term normal allocation because it is presumed to be the “baseline” allocation that will remain in place until the investor’s life circumstances change appreciably (e.g., retirement)
2 - 3
The Importance of the Asset Allocation Decision
In an influential article published in Financial Analysts Journal in July/August 1986, Gary Brinson, Randolph Hood, and Gilbert Beebower examined the issue of how important the initial strategic allocation decision was to an investor
They looked at quarterly return data for 91 pension funds over a ten-year period and decomposed the average returns as follows: Actual Overall Return (IV) Return due to Strategic Allocation (I) Return due to Strategic Allocation and Market Timing (II) Return due to Strategic Allocation and Security Selection (III)
2 - 4
The Importance of the Asset Allocation Decision (cont.)
Graphically:
In terms of return performance, they found that:
2 - 5
The Importance of the Asset Allocation Decision (cont.) In terms of return variation:
Ibbotson and Kaplan support this conclusion, but argue that the importance of the strategic allocation decision does depend on how you look at return variation (i.e., 40%, 90%, or 100%).
2 - 6
Examples of Strategic Asset Allocations
Public Endowments:
2 - 7
Examples of Strategic Asset Allocations (cont.)
Public Retirement Fund:
2 - 8
Examples of Strategic Asset Allocations (cont.)
2 - 9
Asset Allocation and Building an Investment Portfolio
I. Global Market Analysis
- Asset Class Allocation
- Country Allocation Within Asset Classes
II. Industry/Sector Analysis
- Sector Analysis Within Asset Classes
III. Security Analysis
- Security Analysis Within Asset Classes
and Sectors
2 - 10
Asset Allocation Strategies
Strategic Asset Allocation: The investor’s “baseline” asset allocation, taking into account his or her return requirements, risk tolerance, and investment constraints.
Tactical Asset Allocation: Adjustments to the investor’s strategic allocation caused by perceived relative mis-valuations amongst the available asset classes. Ordinarily, tactical strategies overweight the undervalued asset class. Also known as market timing strategies.
Insured Asset Allocation: Adjustments to the investor’s strategic allocation caused by perceived changes in the investor’s risk tolerance. Usually, the asset class that experiences the largest relative decline is underweighted. Portfolio insurance is a well-known application of this approach.
2 - 11
Sharpe’s Integrated Asset Allocation Model
C1 Capital Market Conditions
C2 Prediction Procedure
C3 Expected Returns, Risk
and Correlations
I1 Investor Assets, Liabilities
and Net Worth
I2 Investor's Risk Tolerance
Function
I3 Investor's Risk Tolerance
M1 Optimizer
M2 Investor's Asset Mix
M3 Returns
2 - 12
Sharpe’s Integrated Asset Allocation Model (cont.)
Notice that the feedback loops after the performance assessment box (M3) make the portfolio management process dynamic in nature.
The strategic asset allocation process can be viewed as going through the model once and then removing boxes (C2) and (I2), thus removing any temporary adjustments to the baseline allocation.
Tactical asset allocation effectively removes box (I2), but allows for allocation adjustments due to perceived changes in capital market conditions (C2).
Insured asset allocation effectively removes box (C2), but allows for allocation adjustments due to perceived changes in investor risk tolerance conditions (I2).
2 - 13
Measuring Gains from Tactical Asset Allocation
Example: Consider the following return and allocation characteristics for a portfolio consisting of stocks and bonds only.
Stock BondAllocation: Strategic 60% 40%
Actual 50 50
Returns: Benchmark 10% 7% Actual 9 8
The returns to active management (i.e., tactical and security selection) are:
Policy Performance: (.6)(.10) + (.4)(.07) = 8.80% Actual Performance: (.5)(.09) + (.5)(.08) = 8.50%
Active Return = - 30 bp
2 - 14
Measuring Gains from Tactical Asset Allocation (cont.)
Also: (Policy & Timing): (.5)(.10) + (.5)(.07) = 8.50%
(Policy & Selection): (.6)(.09) + (.4)(.08) = 8.60%
so: Timing Effect: 8.50 – 8.80 = -0.30%
Selection Effect: 8.60 – 8.80 = -0.20%
Other: 8.50 – 8.60 – 8.50 + 8.80 = +0.20%
Total Active = -0.30%
2 - 15
Example of Tactical Asset Allocation: Fidelity Investments
2 - 16
Example of Tactical Asset Allocation: Texas TRS
2 - 17
Example of Tactical Asset Allocation: Texas TRS
2 - 18
Example of Tactical Asset Allocation: UTIMCO
Recommended 2005 Asset Allocation Policy
Asset Category Policy Targets Policy Ranges Benchmark
US Equities 20.0 10 to 30 Russell 3000 Index
Global ex US Equities 17.0 10 to 30Policy target-weighted composite of the sub-indices in this category
Non-US Developed Equity 10.0 MSCI EAFE Index with net dividends Emerging Markets Equity 7.0 MSCI Emerging Markets Index with net dividends
Hedge Funds 25.0 15 to 30Policy target-weighted composite of the sub-indices in this category
Directional Hedge Funds 10.0Combination index: 50% S&P Event-Driven Hedge Fund Index plus 50% S&P Directional/Tactical Hedge Fund Index
Absolute Return Hedge Funds 15.0Combination index: 66.7% S&P Event-Driven Hedge Fund Index plus 33.3% S&P Arbitrage Hedge Fund Index
Private Capital 15.0 5 to 20 Venture Economics' Periodic IRR Index Venture Capital 4.0 Private Equity 11.0
Inflation Linked 13.0 0 to 20Policy target-weighted composite of the sub-indices in this category
REITS 5.0 Wilshire Associates Real Estate Securities Index Commodities 3.0 GSCI Index minus 1% TIPS 5.0 Lehman Brothers US TIPS IndexFixed Income 10.0 5 to 15 Lehman Brothers Aggregate IndexCash 0.0 -10 to 10 91 Day T-Bills
Expected Return> 8.34%1 Year Downside Risk> 7.6%
Standard Deviation> 10.8%95% 1 Year VaR> -13.8%
Illiquidity> 32.4%
Percent of Portfolio (%)
top related