Strategic Asset Allocation Research Articles

Investigating the relationship between high‐yield bonds and equities and its implications for strategic asset allocation during the Great Recession

AbstractIn this paper, we focus on investing in U.S. high‐yield bonds during the period 2007–2013, a period that covers the Great Recession in the aftermath of the global financial crisis of 2007–2008. First, we use the Fama and French three‐factor model to delve into the relationship between the risk‐adjusted returns of high‐yield bonds and equity market risk factors. Second, we gauge the extent to which the risk‐adjusted returns of high‐yield bonds are significantly higher than equity and investment‐grade bonds' risk‐adjusted returns. Third, by using a modified version of the Black–Litterman model, we explore the asset allocation to high‐yield bonds, accounting for investors' risk tolerance. Our findings suggest that equity market risk factors have significant explanatory power for high‐yield bonds' risk‐adjusted returns, whereas the hypothesis of superior returns on high‐yield bonds over investment‐grade corporate bonds and equities cannot be supported. Our key contribution relates to the strategic asset allocation to high‐yield bonds. Our results suggest that the share of high‐yield bonds does not exceed 4.1% of total assets in a global market portfolio over the period 2007–2013. Notably, the share of high‐yield bonds in a simulated portfolio remains relatively small and stable on a risk‐adjusted basis, irrespective of an investor's risk profile or the phase of the business cycle.

Can Investors Benefit from Hedge Fund Strategies? Utility‐Based, Out‐of‐Sample Evidence

We report systematic, out-of-sample evidence on the benefits to an already well diversified investor that may derive from further diversification into various hedge fund strategies. We investigate dynamic strategic asset allocation decisions that take into account investors’ preferences as well as return predictability. Our results suggest that not all hedge fund strategies benefit a long-term investor who is already well diversified across stocks, government and corporate bonds, and REITs. Only strategies whose payoffs are highly nonlinear (e.g., fixed income relative value and convertible arbitrage), and therefore not easily replicable, constitute viable options. Most of the realized economic value fails to result from a mean-variance type of improvement but comes instead from an improvement in realized higher-moment properties of optimal portfolios. Medium to highly risk-averse investors benefit the most from this alternative asset class.

Strategic Asset Allocation With Climate Change

We develop a top-down strategic pathway towards green investing and show that eco-investing should not be a puzzle or a sacrifice if investors consider the unknown impact of climate change on different asset classes. We investigate the impact of climate change over a large universe of asset classes including stocks, bonds, alternatives and a list of green assets which have low-carbon emissions, in terms of their time-varying risk-return trade-offs using a factor-based vector autoregression (VAR) model with climate risk as an additional state variable. Estimation results show that green assets are in general resilient against temperature change, while many grey assets are negatively related to the risk of warming. When simulating future investment opportunity set, we disentangle the climate effects from the return processes and introduce two climate scenarios: an optimistic scenario implied by the VAR estimates; and a pessimistic one based on the DICE model. We find a substantial demand for green assets under the pessimistic scenario, which verifies the hypothesis that investors with a decent awareness of climate change should find it profitable to invest in green.

What Investment Risk Means to You, Illustrated: Strategic Asset Allocation, the Budget Constraint, and the Volatility of Spending during Retirement

In our experience, many investment professionals don’t articulate risk well to clients. This research uniquely and graphically reveals the nature of strategic asset allocation investment risk not only for single-period investors, but also for multi-period investors such as those whose savings are held for retirement. Using Monte Carlo simulations, we evaluate and picture the nature of that multi-period consumption risk with spending rules that are subject to a budget constraint and those that aren’t (such as the 4% rule). Risk in a multi-period context means that realized spending may increase with greater SAA risk, but it may instead be worse.

Developing an Effective Dynamic Beta Overlay

Many institutions – both multi-asset managers and asset owners – have developed Global Tactical Asset Allocation (GTAA) strategies. These strategies could be either long-only or long-short, but are typically fully funded. In an environment where the future expectations of asset and portfolio returns are low, and cash is valuable for pension funds that are often paying more in benefits than they receive in contributions, asset owners need to be creative and re-purpose certain strategies. Many of these GTAA strategies trade assets that are not in the client’s Strategic Asset Allocation (SAA) and GTAA strategies could potentially be adding to total fund risk to the extent they take bets similar to those embedded in the SAA. This paper is an adapted case study to demonstrate how an innovative asset owner that had crowdsourced best ideas from strategic partners to create their own unique GTAA, was able to adapt the GTAA model into a futures-based Dynamic Beta/SMART Rebalancing overlay to not only improve the Sharpe ratio, but also greatly enhance the risk management properties of the overall fund. More importantly, cash utilization was improved because futures overlays need only be financed with limited cash if designed appropriately.

팩터에 기반한 연기금의 전략적 자산배분

팩터에 기반한 연기금의 전략적 자산배분

Heterogeneous dependence and dynamic hedging between sectors of BRIC and global markets

This study examines the dynamic dependence structure via return and volatility spillovers between BRIC (Brazil, Russia, India, and China) and global markets (USA, Europe, and World) at sectoral level. Using directional spillover and dynamic conditional correlation models, we find that there is substantial evidence of heterogeneity across sample sectors within BRIC and between BRIC and global indices. The sectors that exhibit high inter-country spillovers are industrial metal & mining, banking, industrial transportation and oil & gas. The regional and global indices represented by Europe and World show better spillover mechanism than any other indices, implying that these global sectoral indices impact the sectoral indices returns of BRIC markets. The dynamic hedge ratios and portfolio weights suggest that among BRIC, the sectoral indices of China and India provide better opportunities for risk management than Brazil and Russia. We thus conclude that the heterogeneous dependence structure makes BRIC as a diverse asset class from strategic asset allocation perspective.

The Components of Private Debt Performance

In an environment of near-zero yields for traditional asset classes and tightening bank regulation, debt in privately-arranged loans has become an interesting alternative to publicly-distributed bonds for borrowers and professional investors. Key questions for potential investors concern the expected return and risk inherent to such investments, and the diversification benefits they offer for strategic asset allocation. Due to the private nature of these markets, however, historical data are not available at a micro level. For most segments of the market, representative current yield figures for Europe can be only inferred from anecdotal evidence around current transactions or derived from central banks’ aggregate series. In this article, the authors analyze private debt interest rates and the features that are relevant for asset allocation decisions using a mix of non-public data, snap-shot data, and publicly available, highly aggregated historical data on bank loans. By means of regression analysis, the authors find that they can disentangle the main components of private debt rates over time, and assess the existence of a premium related to the illiquidity and complexity of private debt markets. Then, they look for possible diversification opportunities that private debt may offer in asset allocation, and observe that efficient portfolios obtained by investing in private debt are more diversified and achieve higher expected returns for any given level of expected risk than portfolios that do not invest in this asset class.

Dare to Be Different: How to Commit to Investment Beliefs Through Knowledge Management

Knowledge Management (“KM”), in institutional asset management, is defined as the explicit and systematic management of knowledge – and its associated processes of creation, organization, diffusion, use and exploitation – in pursuit of improving portfolio performance and managing risks. Asset owners exist at the nexus of unique knowledge and data flows from partners such as asset managers, banks, and consultants. Innovative asset owners can crowdsource unique data sets from partners and leverage InvestTech to dynamically manage asset allocations (and risk factors). This paper describes the importance of converting KM into a skill that supports alpha generation, and how most asset owners can replicate this process to develop bespoke approaches based on specific relationships, key risks, and objectives. The paper demonstrates how investors can commit to their investment beliefs using KM (or conversely, imply their investment beliefs from investment choices made) around three major areas: (i) investing style (formulaic or discretionary); (ii) optimization method (for setting the Strategic Asset Allocation, (“SAA”) and Tactical Asset Allocation (“TAA”)); and (iii) rebalancing process (mechanical or informed). The paper extends the analysis to show how effective KM can also help with risk-management, with a particular example of a new approach to risk-management, termed “Agent-Based Risk Management,” and also how KM may lead to different implementations for say a public pension plan versus a captive insurance company.

Strategic asset allocation by mixing shrinkage, vine copula and market equilibrium

AbstractWe propose a new portfolio optimization method combining the merits of the shrinkage estimation, vine copula structure, and Black–Litterman model. It is useful for many investors to satisfy simultaneously the three investment objectives: estimation sensitivity, asymmetric risks appreciation, and portfolio stability. A typical investor with such objectives is a sovereign wealth fund (SWF). We use China's SWF as an example to empirically test the method based on a 15‐asset strategic asset allocation problem. Robustness tests using subsamples not only show the method's overall effectiveness but also manifest that the function of each component is as expected.

Equally Weighted Strategic Allocation and Balanced Funds in Brazil

ABSTRACTThis article analyzes equally weighted strategic asset allocation portfolios in Brazil between 2004 and 2016 and shows that their average returns are not always statistically greater than those of balanced funds, with significance changing in sub-periods. Fixed-income portfolios frequently outperform balanced funds, whose active management underperforms their declared benchmark portfolios. Balanced funds underperformed probably because they deviated from their investment policy. Transaction costs and other rebalancing frequencies do not change the conclusions. Robustness tests indicate that this evidence is valid out-of-the-sample. Investors can mimic balanced-fund policy and possibly do better by means of indexing according to this policy.

Pension Funds Interconnections and Herd Behavior

Strategic investment decisions in pension funds are made by trustees. In making these decisions, trustees contract independent advisors such as asset managers and actuaries. Can these external advisors transfer their investment beliefs to the pension funds they contract with? We use proprietary data with the names of asset management firms and individual actuaries that service multiple pension funds to answer this question. We find that pension funds make similar decisions on strategic asset allocations in the presence of a common asset manager or a common actuary, despite significant differences in their liability structures, funding levels, or sizes. The effect is particularly strong in alternative asset classes, such as private equity, hedge funds, and real estate. If two pension funds increase their strategic allocation to alternatives by 10 percentage points in one year, then a third pension fund that contracts the same asset manager increases its strategic allocation to alternatives by 2.5 percentage points, all else being equal. The common-advisor effect might lead a pension fund to select a strategic asset allocation that is not in line with its liability structure, funding ratio, sophistication level, or organizational structure.

Asset Allocation Strategy to Create Superior Portfolio from Equity Mutual Funds

There are many factors that cause an investor's success or failure in investing. One of the most decisive factors is the strategy to allocate investment assets. Therefore, investors need to allocate his or her assets such that an optimal return is achieved. This study discusses three strategies of asset allocation, namely buy and hold, instalment plan, and rebalancing. Three rebalancing processes are applied; quarterly, semi-annually and annually. Thirty active equity mutual funds from 2008 to 2014 have been used as research sample to calculate the superior portfolio. This study uses the Sharpe ratio to calculate portfolio return. The research result shows that strategic asset allocation with rebalancing strategy is considered the best strategy to be applied by investors. This finding can be used by investors as reference to invest in equity mutual funds to enhance returns.

Can Investors Benefit from Hedge Fund Strategies? Utility‐Based, Out‐of‐Sample Evidence

We report systematic, out-of-sample evidence on the benefits to an already welldiversified investor that may derive from further diversification into various hedge fund strategies. We investigate dynamic strategic asset allocation decisions that take into account investors’ preferences as well as return predictability. Our results suggest that not all hedge fund strategies benefit a long-term investor who is already well diversified across stocks, government and corporate bonds, and REITs. Only strategies whose payoffs are highly nonlinear (e.g., fixed income relative value and convertible arbitrage), and therefore not easily replicable, constitute viable options. Most of the realized economic value fails to result from a mean-variance type of improvement but comes instead from an improvement in realized higher-moment properties of optimal portfolios. Medium to highly risk-averse investors benefit the most from this alternative asset class.

(A Survey on the Strategic Asset Allocation Debate)

Korean Abstract: 본 논문은 전략적 자산배분 중요성에 관한 논쟁의 본질을 밝힘으로써 자산배분의 역할에 대한 정확한 이해와 향후 연구방향을 제시하고자 한다. 첫째, 시장수익률의 공헌도를 제외하면 자산배분과 적극적 투자관리가 비슷한 정도로 포트폴리오의 총수익률과 시장초과수익률의 변동성에 영향을 준다. 둘째, 포트폴리오 간 수익률 차이에 대한 자산배분의 중요성은 분석에 따라 차이를 보이지만 Brinson et al.(1986)이 주장하는 90%에는 훨씬 못 미친다. 셋째, 평균적으로 적극적 투자관리가 포트폴리오의 수익률을 저해하고 변동성을 증가시킨다. 그러나 실적이 좋은 펀드와 능력 좋은 펀드매니저를 선택하는 것은 종목선택을 대체할 수 있는 의사결정이다. 넷째, 동적 자산배분은 새로운 정보에 따라 자산배분을 조정하여 더 높은 위험조정수익률을 가능하게 한다. 그러나 동적 자산배분은 단편적이고 즉흥적인 투자관리가 아니라 매크로 측면에서 체계적으로 수행되는 적극적 투자관리로서 전략적 자산배분을 대체하는 것이 아니라 보완한다. English Abstract: The purposes of this study are to straighten the practitioners' misunderstanding about the importance of strategic asset allocation and to provide new perspectives on the asset allocation debate. First, a time-series regression on total return of portfolio is inevitably dominated by market return. After removing the effect of market return, it is found that asset allocation and active management have almost equal importance on the variation of portfolio return. Second, it is better to use a cross-sectional regression to find the relative importance of asset allocation on the difference in return among portfolios. The regression results show much smaller role of asset allocation than results by time-series regression. Third, on average, the active management reduces the return of portfolio and increases risk. Finally, the static asset allocation fails to reflect new changes in the market. Dynamic asset allocation can change asset allocation in response to information for higher risk-adjusted return.

Robustly Strategic Consumption–Portfolio Rules with Informational Frictions

This paper provides a tractable continuous-time, constant absolute risk aversion–Gaussian framework to explore how the interactions of fundamental uncertainty, model uncertainty due to a preference for robustness, and state uncertainty due to information-processing constraints (rational inattention) affect strategic consumption–portfolio rules and precautionary savings in the presence of uninsurable labor income. Specifically, after solving the model explicitly, I compute and compare the elasticities of strategic asset allocation and precautionary savings to risk aversion, robustness, and inattention. Furthermore, for plausibly estimated and calibrated model parameters, I quantitatively analyze how the interactions of model uncertainty and state uncertainty affect the optimal share invested in the risky asset and show that they can provide a potential explanation for the observed stockholding behavior of households with different education and income levels. This paper was accepted by Neng Wang, finance.

The role of high-yield bonds in strategic asset allocation over the Great Recession

By utilizing a modified version of the Black-Litterman model, the authors explore the asset allocation to high-yield bonds based on an investor’s risk profile. In so doing, the researchers use US data on high-yield bonds and over the period 2007–2013. The key finding relates to the strategic asset allocation to high-yield bonds in a simulated global market portfolio depending on an investor’s risk tolerance. In particular, the share of high-yield bonds does not exceed 4.15% of total assets in a global market portfolio over the period 2007–2013, whilst the allocation remains relatively stable and small on a risk-adjusted basis, irrespective of an investor’s risk profile or the phase of the business cycle. In simple terms, the results suggest that high-yield bonds do not seem to merit a favorable treatment in the asset allocation process relative to other financial instruments in a global market portfolio.

Strategic Asset Allocation: Combining Science and Judgment to Balance Short-Term and Long-Term Goals

The authors build on traditional mean–variance optimization with a quantitative framework for combining the best of science and judgment in selecting an asset allocation for long-horizon investors such as endowments. The novelty of their approach lies in its ability to balance the desire for long-term returns with the need to manage short-term risk and funding constraints—important goals that are often in conflict. To reap the benefits of long-term risk premia, investors must be able to withstand occasional short-term painful drawdowns. The authors show how their unified approach can be used to examine how different combinations of asset classes, spending rates, and even alpha impact the policy portfolio over various planning horizons. The framework merges the science of portfolio optimization with a structure that informs sound judgment in determining an organization’s strategic asset allocation and spending policies.

Sustainable Investments and Strategies for the Proprietary Trading of German Savings Banks

This paper analyses the suitability of sustainable investments and strategies for the proprietary trading of German savings banks. The paper employs a preliminary panel data analysis of financial statements of all German savings banks from the years of 2013 to 2015 in order to cluster the German savings banks from passive to active proprietary investment institutions. Based on the results of the clustering, the paper uses a vector error correction model (VECM), combined with a bootstrap simulation analysis, to compare different sustainable investment strategies and conventional investment strategies for the strategic asset allocation of German savings banks by their future return distribution paths.

A Multivariate Model of Strategic Asset Allocation with Longevity Risk

Population-wide increase in life expectancy is a source of aggregate risk. Longevity-linked securities are a natural instrument to reallocate that risk. This paper extends the standard Campbell–Viceira (2005) strategic asset allocation model by including a longevity-linked investment possibility. Model estimation, based on prices for standardized annuities publicly offered by U.S. insurance companies, shows that aggregate shocks to survival probabilities are predictors for long-term returns of the longevity-linked securities, and reveals an unexpected predictability pattern. Valuation of longevity risk premium confirms that longevity-linked securities offer inexpensive funding opportunities to asset managers.