William Jahnke, "The Asset Allocation Hoax". (Page 53), The key point about the efficient frontier is this: it’s a chimera, the image of your Aunt Tillie in a cloud scudding overhead a few minutes ago. Chapter 3 Summary The concept of correlation of assets is central to portfolio theory — the lower the correlation, the better. Here are some excerpts from The risk of an asset or a portfolio can be measured. Optimal allocation can be about: future, hypothetical, historical. Money managers do not exhibit consistent stock-picking skill. Tactical asset allocation is a strategy in which an investor takes a more active approach that tries to position a portfolio into those assets, sectors, or individual stocks that show the most potential for perceived gains. Hypothetical: the process of postulating a set of returns, SDs, and correlations and then calculating the optimal allocations for these inputs.  Even "asset allocation explains 93.6% of quarterly performance variance" leaves much to be desired, because the shared variance could be from pension funds' operating structure. We’ll have to look elsewhere for a coherent allocation strategy. While it may be true that the long-term returns of a highly diversified portfolio are the same as a more conventional portfolio, from time to time it will seriously underperform it.  The conclusion of the study was that replacing active choices with simple asset classes worked just as well as, if not even better than, professional pension managers. Add to del.icio.us. Further, it should be possible to approximate the future long-term return and risk of a portfolio consisting of such assets. (Page 46), The main advantage of international diversification was not increased return but decreased risk. The primary objective of the Fidelity Fund Portfolios–Income is to provide a representation of just one way you might construct a portfolio of Fidelity mutual funds, designed for the purpose of providing a focus on interest and dividend income, over a range of long term risk levels, which are consistent with the asset allocations of a (sub)set of Fidelity’s Target Asset … Decide how many different stock and bond asset classes you are willing to own. The Intelligent Asset Allocator. (Page 59). Consequently, we cannot hope for a risk reduction of more than about one-quarter to one-third from diversification. The authors determine the market values of equities, private equity, real estate, high yield bonds, emerging debt, non-government bonds, government bonds, inflation linked bonds, commodities, and hedge funds. It determines an investor's future return, as well as the bear market burden that he or she will have to carry successfully to realize the returns. (Page 45), Risk dilution: refers to this process of traveling from right to left on a return-versus risk curve. (Page 76). Expectations for return are often derived in the same way.  Thus, explaining variance does not explain performance. Financial advisors often pointed to this study to support the idea that asset allocation is more important than all other concerns, which the BHB study lumped together as Now, in the plain-spoken The Intelligent Asset Allocator, he shows independent investors how to build a diversified portfolio—without the help of a financial advisor. The most important concept in portfolio theory: Dividing your portfolio between assets with. (Page 73), Further diversification benefit can be obtained through the use of international small stocks. A breath of fresh air for investors tired of … Unlike the other three books, this book was relatively short, at only 225 … Because of 1 and 2, it is futile to select money managers on the basis of past performance. In other words, … The corollary of the efficient market hypothesis is that you are better off buying and holding a random selection, or as we have shown above, an index of stocks rather than attempting to analyze the market. The linear correlation between monthly index return series and the actual monthly actual return series was measured at 90.2%, with shared variance of 81.4%. Now, let his plain-spoken The Intelligent Asset Allocator show you how to use the time-honored techniques of asset allocation to build your own pathway to financial security - one that is easy-to … The Intelligent Asset Allocator: How to Build Your Portfolio to Maximize Returns and Minimize Risk Hardcover – 16 Sept. 2000 by William Bernstein (Author) 4.3 out of 5 stars 141 ratings See all formats … Input parameters are for illustration purpose only; actual returns will vary. Also, a small number of asset classes was sufficient for financial planning. The "traditional" asset classes are stocks, bonds, and cash: Allocation among these three provides a starting point. (Page 45), Again, the essence of effective portfolio construction is the use of a large number of poorly correlated assets. The long-run behavior of asset classes does not guarantee their shorter-term behavior. McGuigan described an examination of funds that were in the top quartile of performance during 1983 to 1993. Try to get around this problem with a heavy weighting of large and domestic stocks in its equity portion. (Page xiv), The simplest measure and still practical measure of risk: standard deviation. The addition of a small amount of stock to a bond portfolio increases return while actually reducing risk slightly; even the most risk-averse investor should own some stocks. Today it’s time to recap the fourth and final book in the challenge: The Intelligent Asset Allocator by William Bernstein. If two assets have similar long-term returns and risks and are not perfectly correlated, then investing in a fixed, rebalanced mix of the two not only reduces risk but also actually increases return. In this way, core-satellite allocation strategies are a hybrid of the strategic and dynamic/tactical allocation strategies mentioned above. Book Review: The Intelligent Asset Allocator: How to Build Your Portfolio to Maximize Returns and Minimize Risk By William J Bernstein September 1, 2017 4 Comments “Bernstein has become a guru to … (Page 50), The real purpose of portfolio backtesting, mean-variance analysis, or any other kind of portfolio analysis is not to find the “best” asset mix.  Like strategic allocation strategies, dynamic strategies largely retain exposure to their original asset classes; however, unlike strategic strategies, dynamic asset allocation portfolios will adjust their postures over time relative to changes in the economic environment. Many financial experts argue that asset allocation is an important factor in determining returns for an investment portfolio. Of course, there’s no way to know ahead of time precisely where the efficient frontier will lie for a given period. "Is there really no such thing as a free lunch? Now, with … The Four Layers of Mutual Fund Costs (Page 90-91). In fact, low cost was a more reliable indicator of performance. In 2000, Ibbotson and Kaplan used five asset classes in their study "Does Asset Allocation Policy Explain 40, 90, or 100 Percent of Performance? Usually included are hybrid instruments such as convertible bonds and preferred stocks, counting as a mixture of bonds and stocks. Published in 2001 by William Bernstein, The Intelligent Asset Allocator offers advice on constructing a portfolio of passively managed index funds and ETFs. Asset diversification has been described as "the only free lunch you will find in the investment game". Over the long term, a widely diversified global portfolio of small- and large-company stocks should have favorable return-versus-risk-characteristics. Beware of recency, and do not be overly impressed with asset- class returns over periods of less than two or three decades. However, the difference is still 15 basis points (hundredths of a percent) per quarter; the difference is one of perception, not fact. Level 2: for the individual who is serious about diversification Asset allocation is the implementation of an investment strategy that attempts to balance risk versus reward by adjusting the percentage of each asset in an investment portfolio according to the investor's … 33.33% of the funds dropped to the second quartile. The key to modern portfolio theory is spreading your money across multiple uncorrelated asset classes. A 1991 follow-up study by Brinson, Singer, and Beebower measured variance of 91.5%. Bogle noted that an examination of five-year performance data of large-cap blend funds revealed that the lowest cost quartile funds had the best performance, and the highest cost quartile funds had the worst performance..  Hood, however, rejects this interpretation on the grounds that pension plans, in particular, cannot cross-share risks and that they are explicitly singular entities, rendering shared variance irrelevant. (Page 79) (Page 105), In the end, it is easy to understand why the aggregate efforts of all of the nation’s professional money managers fail to best the market: They are the market. There are many types of assets that may or may not be included in an asset allocation strategy.  Generally speaking, strategic asset allocation strategies are agnostic to economic environments, i.e., they do not change their allocation postures relative to changing market or economic conditions. The Intelligent Asset Allocator The Four Pillars of Investing The Investor's Manifesto I found the following quote on his website appealing: "When I wrote The Intelligent Asset Allocator, I thought I was … A second major lesson of The Intelligent Asset Allocatoris the concept of the “efficient frontier.” The idea is that, for any given period, there are a number of efficient portfolios, each of which provides the highest return for a given level of volatility, or the lowest volatility for a given level of return. How “conventional” a portfolio do I want? Excerpts from The Intelligent Asset Allocator - Part II Last updated on May 31, 2020 17 min read reading After building a solid concept of asset allocation and portfolio theory , the second … If you are unable to tolerate much tracking error, keep your proportion of foreign and small-cap stocks low. The longer a risky asset is held, the less the chance of a poor result. But if we look at enough periods, we can get a sense of the types of portfolios that tend to be pretty close, thereby allowi… This portfolio shows the relative value of all assets according to the market crowd, which one could interpret as a benchmark or the optimal portfolio for the average investor. Adjust your stock-versus-bond mix according to how much risk you can tolerate, ranging from a maximum of 75% stock for the most aggressive investors down to 25% for the least aggressive. The first part (Chapter 1 to Chapter 6) is to convey the concept of asset allocation and portfolio theory, the rationale behind it, and how does it manifest in the real market. Investors' risk tolerance is not knowable ahead of time. The two quarterly return series' linear correlation was measured at 96.7%, with shared variance of 93.6%. , Doeswijk, Lam and Swinkels (2019) show that the global market portfolio realizes a compounded real return of 4.45% per year with a standard deviation of 11.2% from 1960 until 2017. William Bernstein, both a neurologist and a founder of his own money management firm, is the author of the challenging but information-packed book The Intelligent Asset Allocator (my … I will soon finish The Intelligent Asset Allocator and I was wondering if there was any book that would be a good complement (more advanced). Otherwise I will simply read books specialized in equities, commodities, REITs, fixed income, etc to have a better understanding of my allocation. A study with such broad coverage of asset classes has not been conducted before, not in the context of determining capital market expectations and performing a mean-variance analysis, neither in assessing the global market portfolio. (Page 45), The stock composition of a high-risk portfolio usually does not differ much from that of a low-risk portfolio. Meir Statman, "The 93.6% Question of Financial Advisors", L. Randolph Hood, Response to Letter to the Editor, The Financial Analysts Journal 62/1, January/February 2006. Level 1: you can get most of the diversification of far more complex portfolios from this short list. The tables show why asset allocation is important. A 2000 paper by Meir Statman found that using the same parameters that explained BHB's 93.6% variance result, a hypothetical financial advisor with perfect foresight in tactical asset allocation performed 8.1% better per year, yet the strategic asset allocation still explained 89.4% of the variance. Dynamic asset allocation is similar to strategic asset allocation in that portfolios are built by allocating to an asset mix that seeks to provide the optimal balance between expected risk and return for a long-term investment horizon. The most common forms of asset allocation are: strategic, dynamic, tactical, and core-satellite. However, I … The aggressiveness of your portfolio is reflected in your overall stock and bond mix, not in the kinds of equity you hold, which should be similar at all levels of risk.  The Jahnke discussion appeared in the Journal of Financial Planning as an opinion piece, not a peer reviewed article. In the inflationary period from 1960 to 1979, the compounded real return of the global market portfolio is 3.24% per year, while this is 6.01% per year in the disinflationary period from 1980 to 2017. The Intelligent Asset Allocator (IAA) by William Bernstein does exactly what it says on the cover, it teaches you ‘how to build your portfolio to maximize returns and minimize risk’. This will increase your long-term return and enhance investment discipline. In 1997, William Jahnke initiated a debate on this topic, attacking the BHB study in a paper titled "The Asset Allocation Hoax". -- The Intelligent Asset Allocator, preface The first two chapters provide an overview of risk, standard deviation, and return, and discusses historical risk/return of T-bills, treasuries, stocks, … Forget about getting the answer from a magic black box. The primary goal of strategic asset allocation is to create an asset mix that seeks to provide the optimal balance between expected risk and return for a long-term investment horizon. Gary Brinson has expressed his general agreement with the Ibbotson-Kaplan conclusions. " The asset classes included were large-cap US stock, small-cap US stock, non-US stock, US bonds, and cash. Faber, Mebane T., "A Quantitative Approach to Tactical Asset Allocation". As a first approximation, assume that it is equal to the spread. Increasing the number of asset classes you employ will improve diversification but will also increase your work load and tracking error. and wants its full benefit. (Page 87). Your precise asset allocation will depend on three factors: your tolerance to S&P 500 tracking error, the number of assets you wish to own, and your tolerance to risk. The indexed quarterly return was found to be higher than the pension plan's actual quarterly return. A fundamental justification for asset allocation is the notion that different asset classes offer returns that are not perfectly correlated, hence diversification reduces the overall risk in terms of the variability of returns for a given level of expected return. However, by applying intelligent asset allocation, your individual portfolio risk can be managed (even minimized) while at the same time achieving reasonable rates of investment return. Doeswijk Ronald Q., Lam Trevin and Swinkels Laurens, "Strategic Asset Allocation: The Global Multi-Asset Market Portfolio 1959–2012", Doeswijk Ronald Q., Lam Trevin and Swinkels Laurens, "Historical Returns of the Market Portfolio", Working Paper, The Implications of Style Analysis on Mutual Fund Performance Evaluation, Stock price correlation analysis with selectable asset class matrix, Model portfolios for buy and hold index investors, Analyze your portfolio for its current asset allocation, Calculator for determining allocation of retirement assets, and related risk questionnaire, Calculator which determines future asset mix based on differing growth rates and contributions, https://en.wikipedia.org/w/index.php?title=Asset_allocation&oldid=969027401, Short description is different from Wikidata, Creative Commons Attribution-ShareAlike License, Collectibles such as art, coins, or stamps. … The addition of a small amount of bonds to a stock portfolio significantly reduces risk while reducing return only slightly. One could compound 2% and 2.15% quarterly over 20 years and see the sizable difference in cumulative return. Although the risk is reduced as long as correlations are not perfect, it is typically forecast (wholly or in part) based on statistical relationships (like correlation and variance) that existed over some past period. The more exotic asset classes you add to your mix, the higher your tracking error will be. Because of 1, 2, and 3, the most rational way to invest in stocks is to use low-cost passively managed vehicles, i.e., index funds. One's true risk tolerance can be hard to gauge until having experienced a real bear market with money invested in the market. Do not expect safety without correspondingly low returns. Historical investment returns and risks of various asset classes should be studied. Diversifying your portfolio among uncorrelated assets reduces … The serviceable portfolio: the “simpleton’s portfolio” consisting of index funds—one quarter each of: The essence of portfolio theory: diversified portfolios behave very differently than the individual assets in them, in much the same way that a cake tastes different from shortening, flour, butter, and sugar. (Page 105). Rather, it is to find a portfolio mix that will not be too far off the mark under a wide variety of circumstances. Future: Get a competent pilot for your Gulfstream V now. How much risk do I want to take? (Page 72), Probably of greater importance than the risk reduction derived from diversification is the “rebalancing bonus,” the extra return produced by rigorous rebalancing. Thomas P. McGuigan, "The Difficulty of Selecting Superior Mutual Fund Performance". (Page 80). As there is no guarantee that past relationships will continue in the future, this is one of the "weak links" in traditional asset allocation strategies as derived from MPT. (Page 72), This is why simple portfolio backtesting is a valuable supplement to MVO (mean-variance optimizer); one can actually see how well a proposed portfolio responded in an actual bear market. For the main asset categories equities, real estate, non-government bonds, and government bonds they extend the period to 1959 until 2012. The average return during recessions was -1.96% per year, versus 7.72% per year during expansions. Favor short-term bonds (of six months to five years) as your “risk diluting” asset, rather than long-term bonds. The Intelligent Asset Allocator has helped thousands of people like you build wealth through carefully diversified portfolios. Core-satellite allocation strategies generally contain a 'core' strategic element making up the most significant portion of the portfolio, while applying a dynamic or tactical 'satellite' strategy that makes up a smaller part of the portfolio. The results suggest that real estate, commodities, and high yield add the most value to the traditional asset mix of stocks, bonds, and cash. The reward for the average investor over the period 1960 to 2017 is a compounded return of 3.39% points above the risk-less rate earned by savers.. , Bekkers, Doeswijk and Lam (2009) investigate the diversification benefits for a portfolio by distinguishing ten different investment categories simultaneously in a mean-variance analysis as well as a market portfolio approach. However, in response to a letter to the editor, Hood noted that the returns series were gross of management fees.. (Page 74), How many different asset classes do I want to own? For this range of assets, they estimate the invested global market portfolio for the period 1990 to 2012. The easiest way to do this is by calculating the standard deviation of returns for many time periods.  The statistics were most helpful when used to demonstrate the similarity of the index return series and the actual return series. Small stocks have to be diluted with more bonds than large stocks in order to obtain the same degree of risk (i.e., a 50/50 small-stock62 The Intelligent Asset Allocator and bond mix will have about the same degree of risk as a 75/25 large-stock and bond mix). Such a strategy contrasts with an approach that focuses on individual assets. Simply buying stocks without regard of a possible bear market can result in panic selling later. Market-impact costs: the magnitude of impact costs depends on the size of the fund, the size of the company, and the total amount transacted. Those who are ignorant of investment history are bound to repeat its mistakes. Ibbotson and Kaplan examined the 10-year return of 94 US balanced mutual funds versus the corresponding indexed returns. Risk is controlled by the overall mix of stocks and bonds. (Page 8), One sign of a dangerously overbought market is a generalized underappreciation of the risks inherent in it. (Page 64). Blitz, David and Van Vliet, Pim, "Global Tactical Cross-Asset Allocation: Applying Value and Momentum Across Asset Classes". Now, with global markets in constant flux, balancing risk and … An asset class is a group of economic resources sharing similar characteristics, such as riskiness and return. The correlation of two assets can be expressed by a. (Page ix). Roger G. Ibbotson and Paul D. Kaplan, "Does Asset Allocation Policy Explain 40%, 90%, or 100% of Performance?". Jahnke's main criticism, still undisputed, was that BHB's use of quarterly data dampens the impact of compounding slight portfolio disparities over time, relative to the benchmark. It is impossible to forecast future optimal portfolios by any technique. William Bernstein, a very practical hands-on guide on how to derive a feasible asset allocation plan suitable for yourself. When such backward-looking approaches are used to forecast future returns or risks using the traditional mean-variance optimization approach to the asset allocation of modern portfolio theory (MPT), the strategy is, in fact, predicting future risks and returns based on history. Asset allocation is the implementation of an investment strategy that attempts to balance risk versus reward by adjusting the percentage of each asset in an investment portfolio according to the investor's risk tolerance, goals and investment time frame. Bid-ask spread: of stocks bought and sold, and may be as large as 10% for the smallest stocks. Risk and reward are inextricably intertwined. Studies of these forecasting methods constitute an important direction of academic research. A more common sense explanation of the Brinson, Hood, and Beebower study is that asset allocation explains more than 90% of the volatility of returns of an overall portfolio, but will not explain the ending results of your portfolio over long periods of time.
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