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Asset Allocation


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2 Asset Allocation Methodologies
Graham & Dodd (Value Investing), MPT
Columbia University (1934)
Graham & Dodd - University of Origin
University of Chicago
MPT - University of Origin
Graham & Dodd - Approach
Financial Statements, Dividend Discount Modeling, Forward Looking, Very Tedious.
MPT - Approach
Distributional, Modeling of Price Movements (Returns), Backwards Looking (Historical Volatility as a Proxy for Risk), More Practical.
Using Historical Std. Dev. and Correlation is?
A GOOD assumption because they create a SMALL historical variance.
Using Historical Returns is?
A BAD assumption because they create a LARGE historical variance.
Using Expected Returns is?
A GOOD assumption because it uses correlation(beta) to create LESS historical variance.
US T-Bill
Proxy for Risk Free Rate
Proxy for Market Return
MSCI World (CAPM is everything)
Why Constrained Optimization
Negates overreaching and falls closer in line with CAPM assumptions.
Time Frame - Issue
Too little data can create a lack of statistical significance. Too much data can lead to a lack of statistical relevance.
Non-Constant Std. Dev. and Correlation - Issue
Will make historical data less relevant, therefore making forward assumptions less reliable.
Garbage In Garbage Out (GIGO) - Issue
Models are biased to time frame chosen.
Different Efficient Frontiers - Issue
Standard Deviation (proxy for the model) is not the best proxy for risk, when establishing a efficient frontier.
Spending Policy Determination
Always take into account inflation, use the Geometric Average not the Arithmetic Average.
Buy and Hold - Strategic Allocation
NO REBALANCING. The initial mix is purchased and held.
Constant Mix - Strategic Allocation
REBALANCING. Rebalanced to a constant mix.
CPPI - Definition
Constant Proportion Portfolio Insurance
CPPI - Strategic Allocation
REBALANCING. Determines a floor where equity exposure cannot fall below. Invests constant proportion of difference between assets and floor into equities.
Buy and Hold - Curve
LEVEL Strategy that creates a LINEAR Payoff Diagram.
Constant Mix - Curve
CONTRARIAN Strategy that creates a CONCAVE Payoff Diagram.
CPPI - Curve
MOMENTUM Strategy that creates a CONVEX Payoff Diagram.
CPPI outperforms Constant Mix.
Constant Mix vs. CPPI in a Trending Market
Constant Mix outperforms CPPI.
Constant Mix vs. CPPI in a Oscillating Market
No Rebalancing Costs and Tax Efficient.
Buy and Hold - Rebalancing Costs and Taxes
Rebalancing Costs and potentially material taxes.
Constant Mix - Rebalancing Costs and Taxes
CPPI - Rebalancing Costs and Taxes
Highest Rebalancing Costs and potentially material taxes.