Asset Allocation Approaches

Mean-variance Frontier – the outer edge of all possible risky asset (R vs sigma)

Efficient Frontier – with the highest return for a give sigma

Global Minimum Variance

Once 2 points on the efficient frontier are determined, any points can be found from these 2 points

Resampling Efficient Frontier

Regenerate the same efficient frontier with different weights. Then average the weights of each asset to form the final efficient frontier. This is more stable.

Black Litterman Approach

Use the value-weighted global market index to estimate the return and then use mean-variance approach. This usually yields a more diversified profile

Monte Carlo Simulation: Allow dynamic allocation to yield the highest long term return

ALM Efficient Frontier

-       Surplus efficient frontier

-       Asset – liability vs sd_surplus

-       Funding ratio = Asset/Liability (can be used in x-axis)

Experience-Based Techniques

-       100-age % in equity

-       60% in equity

Constraint Portfolio

-       Cannot short sell

-       When one of the asset dropped from positive to 0 weight, this is a corner portfolio

-       Sigma of portfolio formed by linear combination of corner portfolios can be formed by linear combinations of the sigmas of the corner portfolio

SD = weighted average of adjusted corner portfolio

Corner portfolios are those at with zero % of certain asset

If there is short term need, need to allocate cash in treasury note

Capital Market Line: The tangency portfolio has the highest Sharpe Ratio

If required rate of return is higher than the tangency portfolio, need leverage

If IPS does not allow leverage, need to select other portfolio as the "tangency" portfolio

Institutes tends to use ALM

Individuals look to meet desired requirement

A successful Endowment or foundation should be able to meet the current need, protect principal from inflation and the future growth

Insurance company needs segmentation corresponding to their product lines

Banking needs to match duration

Tactical Asset Allocation (TAA): for disequilibria

Usually use derivative to achieve – buying or selling equity index

If see interest rate changes, will use derivative to change duration