The New Science of Asset Allocation: Risk Management in a Multi-Asset World (Wiley Finance)

317 Pages·2010·4.46 MB·English

by  Thomas Schneeweis

The New
Science of
Asset Allocation
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The New
Science of
Asset Allocation
Risk Management in
a Multi-Asset World
THOMAS SCHNEEWEIS
GARRY B. CROWDER
HOSSEIN KAZEMI
John Wiley & Sons, Inc.
Copyright © 2010 by Thomas Schneeweis, Garry B. Crowder, and Hossein Kazemi. All
rights reserved.
Published by John Wiley & Sons, Inc., Hoboken, New Jersey.
Published simultaneously in Canada.
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Library of Congress Cataloging-in-Publication Data:
Schneeweis, Thomas.
The new science of asset allocation : risk management in a multi-asset world / Thomas
Schneeweis, Garry B. Crowder, Hossein Kazemi.
p. cm.
Includes bibliographical references and index.
ISBN 978-0-470-53740-4 (cloth)
1. Asset allocation. 2. Risk management. I. Crowder, Garry B., 1954- II. Kazemi,
Hossein, 1954- III. Title.
HG4529.5.S3366 2010
332.6--dc22
2009047243
Printed in the United States of America
10 9 8 7 6 5 4 3 2 1
Contents
Preface xi
Acknowledgments xix
CHAPTER 1
A Brief History of Asset Allocation 1
In the Beginning 3
A Review of the Capital Asset Pricing Model 4
Asset Pricing in Cash and Derivative Markets 6
Models of Return and Risk Post-1980 11
Asset Allocation in the Modern World 14
Product Development: Yesterday, Today,
and Tomorrow 15
Notes 17
CHAPTER 2
Measuring Risk 20
What Is Risk? 22
Traditional Approaches to Risk Measurement 24
Classic Sharpe Ratio 26
Other Measures of Risk Assessment 28
Portfolio Risk Measures 30
Other Measures of Portfolio Risk Measurement 33
Value at Risk 34
Notes 37
CHAPTER 3
Alpha and Beta, and the Search for a True Measure
of Manager Value 39
What Is Alpha? 39
Issues in Alpha and Beta Determination 46
Problems in Alpha and Beta Determination 48
Multi-Factor Return Estimation: An Example 50
Tracking Alternatives in Alpha Determination 54
Notes 56
v
vi CONTENTS
CHAPTER 4
Asset Classes: What They Are and Where to Put Them 58
Overview and Limitations of the Existing Asset
Allocation Process 59
Asset Allocation in Traditional and Alternative
Investments: A Road Map 61
Historical Return and Risk Attributes and Strategy
Allocation 66
Traditional Stock/Bond Allocation versus Multi-Asset
Allocation 70
Risk and Return Comparisons Under Differing
Historical Time Periods 71
Extreme Market Sensitivity 74
Market Segment or Market Sensitivity:
Does It Matter? 82
How New Is New? 84
Notes 88
CHAPTER 5
Strategic, Tactical, and Dynamic Asset Allocation 91
Asset Allocation Optimization Models 92
Strategic Asset Allocation 99
Tactical Asset Allocation 101
Dynamic Asset Allocation 107
Notes 109
CHAPTER 6
Core and Satellite Investment: Market/Manager
Based Alternatives 110
Determining the Appropriate Benchmarks and
Groupings 111
Sample Allocations 117
Core Allocation 119
Satellite Investment 120
Algorithmic and Discretionary Aspects of
Core/Satellite Exposure 120
Replication Based Indices 122
Peer Group Creation—Style Purity 126
Notes 132
Contents vii
CHAPTER 7
Sources of Risk and Return in Alternative Investments 134
Asset Class Performance 135
Hedge Funds 139
Managed Futures (Commodity Trading Advisors) 143
Private Equity 148
Real Estate 153
Commodities 160
Notes 166
CHAPTER 8
Return and Risk Differences among Similar Asset
Class Benchmarks 167
Making Sense Out of Traditional Stock and
Bond Indices 168
Private Equity 170
Real Estate 173
Alternative REIT Investments Indices 179
Commodity Investment 179
Hedge Funds 185
Investable Manager Based Hedge Fund Indices 185
CTA Investment 189
Index versus Fund Investment: A Hedge Fund Example 189
Notes 194
CHAPTER 9
Risk Budgeting and Asset Allocation 195
Process of Risk Management: Multi-Factor Approach 195
Process of Risk Management: Volatility Target 200
Risk Decomposition of Portfolio 202
Risk Management Using Futures 203
Risk Management Using Options 206
Covered Call 206
Long Collar 208
Notes 210
CHAPTER 10
Myths of Asset Allocation 212
Investor Attitudes, Not Economic Information,
Drive Asset Values 213
Diversifi cation Across Domestic or International
Equity Securities Is Suffi cient 214
viii CONTENTS
Historical Security and Index Performance Provides a
Simple Means to Forecast Future Excess
Risk-Adjusted Returns 215
Recent Manager Fund Return Performance
Provides the Best Forecast of Future Return 215
Superior Managers or Superior Investment Ideas
Do Not Exist 216
Performance Analytics Provide a Complete Means
to Determine Better Performing Managers 216
Traditional Assets Refl ect “Actual Values”
Better Than Alternative Investments 217
Stock and Bond Investment Means Investors
Have No Derivatives Exposure 217
Stock and Bond Investment Removes Investor
Concerns as to Leverage 218
Given the Effi ciency of the Stock and
Bond Markets, Managers Provide No Useful Service 218
Investors Can Rely on Academics and Investment
Professionals to Provide Current Investment Models
and Theories 218
Alternative Assets Are Riskier Than Equity
and Fixed Income Securities 219
Alternative Assets Such as Hedge Funds Are
Absolute Return Vehicles 220
Alternative Investments Such as Hedge Funds
Are Unique in Their Investment Strategies 221
Hedge Funds Are Black Box Trading Systems Unintelligible to
Investors 222
Hedge Funds Are Traders, Not Investment
Managers 222
Alternative Investment Strategies Are So Unique
That They Cannot Be Replicated 223
It Makes Little Difference Which Traditional or Alternative
Indices Are Used in an Asset Allocation Model 223
Modern Portfolio Theory Is Too Simplistic to
Deal with Private Equity, Real Estate, and
Hedge Funds 223
Notes 225
CHAPTER 11
The Importance of Discretion in Asset Allocation Decisions 226
The Why and Wherefore of Asset Allocation Models 226
Value of Manager Discretion 230