An asset allocation model for active portfolios

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76 s M anagers of active investment portfolios 2 frequently attempt To forecast stock market returns in order to decide how to distribute their funds between stocks and fixed-dollar assets. Our purpose in this study is to develop a model that explains stock market returns and that makes fund allocations more efficient. The project has two phases. The first is to design a multiple regression model that might help to explain the annual rate of return of the stock ma,rket. The second is to determine whether a model that reflects this explanation could provide a portfolio strategy indicator that the manager can apply to making asset allocation decisions in an active portfolio. Before developing a new model and trading rules for determining asset allocations, however, we might ask how successfully managers have performed this task in the past. After all, pension fund administrators as a class have been busier than most institutional investors in varying their portfolio asset mix in equities over the years.’ Table I shows the percent of common stocks held in the portfolios of private non-insured pension funds in each of the past 25 years. Although several different factors can account for shifts in asset mix over time, such as changes in pension plan objectives and legal standards, Table I suggests several policy rules, particularly in conjunction with annual stock market returns as measured by the Standard & Poor’s Stock Index. One rule in evidence is a passive policy, which allows the percent of the portfolios in stocks to fluctuate with the stock market cycle. Observe that the z Fi