DYNAMIC ASSET ALLOCATION STRATEGY

Submitted to:Dr. Mahmood Osman Imam Course InstructorCourse: D304, Financial ModelingBangladesh Institute of Capital MarketSubmitted by :

Saied Mahmud ZubayerPGDCM, 1st BatchID-2015-01-06

Methods of Asset Allocation

Strategic Asset Allocation Constant-Weighting Asset

Allocation: Tactical Asset Allocation Insured Asset Allocation Integrated Asset Allocation Dynamic Asset Allocation

Dynamic Asset Allocation

Dynamic Asset Allocation is a portfolio management strategy that involves rebalancing a portfolio so as to bring the asset mix back to its long-term target. Such rebalancing would generally involve reducing positions in the best-performing asset class, while adding to positions in underperforming assets. The general premise of dynamic asset allocation is to reduce the fluctuation risks and achieve returns that exceed the target benchmark

Goals of dynamic asset allocation

Reducing risk & achieving higher risk adjusted return

Reducing risk without sacrificing performance

Importance of dynamic asset allocation

The cyclical moves of financial markets:

Increase in returns utilizing efficient investing decision:

Efficiency of the strategy with mutual funds

Existence of Bear markets Importance of technology

Benefits of dynamic asset allocation

Avoiding bear markets and periods of under-performance in the various asset classes--either by reducing or eliminating the allocation of the under-performing asset (e.g., getting out of the market).

Increasing the allocation of asset classes currently in bull markets that are over-performing.

Dynamic asset allocation eliminates the key weakness found in the traditional, fixed approach that routinely allows periods of under-performance.

The portfolio mix of our generic Model Portfolios will shift dynamically over time to avoid periods of under-performance and move into investment types that are performing well. The net effect is reduced losses, lower volatility, higher average returns and a much stronger risk-adjusted return.

Portfolio Insurance Process Portfolio insurances a dynamic trading

strategy designed to protect a portfolio from market declines while preserving the opportunity to participate in market advances.

Application of Dynamic Asset Allocation(Selection of Securities)

Assumptions :

Total amount of investment Tk. 10, 00,000. 91 Days T-Bill as Risk Free Asset. Here one Quarter is considered as one time interval Price data and dividend data are collected mainly

for the year 2015, as I have considered investment horizon to be in the year 2015.

Continuous compounded risk free rate is assumed. The amount of Tk. 100,000 will be distributed

among the 10 securities equally. Initial distribution of total fund is considered to be 50: 50 in

securities and T-bills.

Criteria for Company Selection

Company must be listed in the Dhaka Stock Exchange.

Listed before January 2015. Ten different companies from five different industries Dividend:. Earnings per share: P/E ratio: Return on equity: Industry position: Profitability. Industry profitability

Dividend Adjustment

The new closing price (for bonus adjustment) = Previous Closing Price * (1+ bonus share rate)

The new closing price (for cash dividend adjustment) = Previous Closing Price + (Face Value*% of cash dividend)

The new closing price (for bonus adjustment) = Previous Closing Price * (1+ bonus share rate)

The new closing price (for cash dividend adjustment) = Previous Closing Price + (Face Value*% of cash dividend)

T-bill value

T-bill value:I have collected the 91 days t-bill rate of fiscal year 2015 on annual basis. Then I have converted the t-bill rate to quarter basis equally. I have calculated the total value to be invested through continuous compounding with that t-bill rate in each quarter

  30/03/2015 29/06/2015 28/09/2015 28/12/2015

T-bill Rate 7.49% 5.41% 5.39% 3.00%91 Days T-bill Rate 1.87% 1.35% 1.35% 0.75%

Determining Up and Down Factor:

Up factor: In order to calculate the insured portfolio I have calculated up

factors through EXP (Δ t*STD) Continuously on each quarter.Down factor: In order to calculate the insured portfolio I have calculated up

factors through EXP (-Δ t*STD) Continuously on each quarter.In the calculation of up and down factor I have divided 252 trading

days by 4 and will get 62 to 64 trading days for each quarter. So our Δ t will be square root of 63 trading days.

Allocation of Asset This part has been done in 2 parts- static

allocation and dynamic allocation. In doing the static asset allocation, 4 scenarios are considered namely-

100% Investment in Equity portfolio i.e. Risky Portfolio.

100% Investment in T – Bill i.e. Risk free portfolio. 50% - 50% investment in Equity and T – Bill

(Constant weight) Static 50% - 50% investment in Equity and T – Bill

Process of dynamic asset allocation

Price Binomial Tree Call Option Value Tree Call Option Delta Tree Put option dynamics Insured portfolio Dynamic Asset allocation

Return series

Return series is calculated by the LN function multiplied by the (dividend adjusted price T/dividend adjusted price T-1). All the return series of the selected companies have been found in this way.

Variance-covariance matrix

Variance-covariance matrix is calculated from the return series of the respective shares data. Equal weight is given in each of the shares investments.

Portfolio variance & Standard Deviation

Up and Down Values

100% Equity Binomial Tree with u & d

50% Equity Binomial Tree with u & d

P Value Calculation and Treasury bill rate:

Call Option Value Tree (Process)

Delta Calculations:

Call option Delta

Put Option value

Insured Portfolio

Dynamic Asset Allocation

I have already assumed that total portfolio consists of risky and risk free investments. Risky assets are shares and risk free assets are 91 day T-bills. At quarter zero we have 1000000 tk. investments and we want to insure our portfolio to 1000000tk. Our delta is 0.500 that means the proportion of shares is (0.50*1000000) =500000 tk. and T-bills are 50000 tk. thus we have insured our portfolio by using delta of the portfolio

Static Allocation

Static Allocation vs. Dynamic Asset Allocation

Findings & Conclusion

Finally, it can be said that, dynamic asset allocation strategy is the better model of portfolio investment in comparison with the static asset allocation strategy. This method provides the basis for adjustment in asset proportion in the portfolio in terms of the changes in prices of the underlying securities. This is a continuous process of changing the portfolio combination and structure which provides better insurance of the portfolio value indicating the supremacy above all other methods of portfolio construction.