1. The Asset Allocation Question
by Richard A. Ferri, CFA
The process of asset allocation begins by putting dollar figures on subjective goals like financial security, a comfortable retirement, and providing for children.
2. Beyond Markowitz: A Comprehensive Wealth Allocation Framework for Individual Investors
by Ashvin B. Chhabra
The Wealth Allocation Framework enables individual investors to construct appropriate portfolios using all their assets, such as their home, mortgage, market investments and human capital.
3. Human Capital, Asset Allocation, and Life Insurance
by Ibbotson, Roger G., Chen, Peng, Milevsky, M.A. and Zhu, Xingnong
Thus, human capital affects both the optimal asset allocation and the optimal demand for life insurance. Yet historically, asset allocation and life insurance decisions have consistently been analyzed separately both in theory and practice.
4. Lifetime Financial Advice: Human Capital, Asset Allocation, and Insurance
by Roger G. Ibbotson, Moshe A. Milevsky, Peng Chen, CFA, and Kevin X. Zhe (2007)
We can generally categorize a person’s life into three financial stages. The first stage is the growing up and getting educated stage. The second stage is the working part of a person’s life, and the final stage is retirement. This monograph focuses on the working and the retirement stages of a person’s life because these are the two stages when an individual is part of the economy and an investor. Even though this monograph is not really about the growing up and getting educated stage, this is a critical stage for everyone. The education and skills that we build over this first stage of our lives not only determine who we are but also provide us with a capacity to earn income or wages for the remainder of our lives. This earning power we call “human capital,” and we define it as the present value of the anticipated earnings over one’s remaining lifetime. The evidence is strong that the amount of education one receives is highly correlated with the present value of earning power. Education can be thought of as an investment in human capital. One focus of this monograph is on how human capital interacts with financial capital. Understanding this interaction helps us to create, manage, protect, bequest, and especially, appropriately consume our financial resources over our lifetimes. In particular, we propose ways to optimally manage our stock, bond, and so on, asset allocations with various types of insurance products. Along the way, we provide models that potentially enable individuals to customize their financial decision making to their own special circumstances.
5. Asset Allocation and Long-Term Returns: An Empirical Approach
by Stephen Coggeshall and Guowei Wu
(...)we describe a heuristic, empirical approach that uses concepts of Shortfall Risk as an objective and actual data as a direct model of the stochastic market evolution.
6. Portfolio Performance and Strategic Asset Allocation Across Different Economic Conditions
by Sa-Aadu, Jarjisu, Shilling, James D. and Tiwari, Ashish
contributed by Barry
Our key result is that commodities and precious metals, and equity REITs are the two asset classes that deliver portfolio gains when consumption growth is low and/or volatile, i.e., when investors really care for such benefits. Consistent with these results, our examination of investor portfolio allocations using a regime switching framework reveals that during the 'bad' economic state, the mean-variance optimal risky portfolio is tilted towards equity REITs, precious metals, and Treasury bonds. Our analysis highlights an important metric by which to judge the attractiveness of an asset class in a portfolio context, namely the timeliness of the gains in portfolio performance.
7. How to Evaluate a New Diversifier with 10 Simple Questions
by Kat, Harry M. (December 2006)
In this paper we discuss a number of important questions to ask when analysing a new alternative diversifier from either a stand-alone, asset-only or asset-liability point of view. The framework is simple, but highly effective. Apart from the new diversifier's statistical properties, it emphasizes the importance of properly accounting for parameter uncertainty and illiquidity; two elements very often ignored by investors. It also shows the importance of taking the correct perspective when evaluating a new diversifier. What looks good from a stand-alone perspective need not look good in a portfolio context and vice versa. Application of the above framework to funds of hedge funds, commodities and synthetic funds underlines the advantages and disadvantages of these diversifiers and clearly points at synthetic funds as the most and funds of hedge funds as the least attractive of the three.
contributed by Barry
The Ten Questions To Ask
1. What risk premium is offered?
2. How volatile are the returns?
3. Are returns positively or negatively skewed or explicitly floored or capped?
4. How certain are you of the above?
5. How liquid is the investment?
6. Is the fee charged fair in relation to the above?
7. What is the correlation with the existing portfolio?
8. What is the co-skewness with the existing portfolio?
9. What is the correlation with the liabilities?
10. What is the co-skewness with the liabilities?
8. Reverse Asset Allocation: Alternatives At The Core
by P. Brett Hammond, TIAA-CREF Asset Management (2007)
Institutional investors have shown an increasing interest in alternative asset classes—including private equity, venture capital, real estate, commodities, hedge funds, and others—due to their strong performance and low correlations with traditional assets. In addition, diminished expectations for returns from traditional assets have made alternative assets even more attractive. The inclusion of alternatives in formal asset allocation models, however, can make these models highly sensitive to small changes in a portfolio’s allocations. Moreover, because most alternatives do not have long track records, some institutions may be unsure how to predict the risk/return behavior of these investments in a traditional asset allocation model.
A new approach—“reverse asset allocation”—addresses these challenges by taking into account the special characteristics of alternative assets. Unlike traditional asset allocation, which, to produce the bulk of overall return, puts equities at the core of the portfolio and then, to limit risk and improve efficiency, adds bonds plus alternatives, reverse asset allocation does the opposite. It begins by finding the expected return from a desired allocation to a core group of alternative assets, and then adds bonds and equities as the completion elements, to achieve the overall desired portfolio characteristics. the rationale for reversing the usual approach is based on the notion that alternatives offer an opportunity to obtain asset-based return alpha with low correlation to traditional asset classes while limiting risk.