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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.
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.