SUMMARY

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SUMMARY

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This summary outlines the key concepts and considerations in asset allocation within investment management. It highlights the importance of effective investment governance, which ensures decisions are made by qualified individuals or groups. This includes setting long- and short-term objectives, allocating decision rights, and establishing processes for investment policy and strategic asset allocation development, as well as monitoring and auditing mechanisms.

It discusses the economic balance sheet concept, emphasizing the inclusion of non-financial assets and liabilities for optimal asset allocation. The summary differentiates between asset-only, liability-relative, and goals-based asset allocation approaches, each focusing on different aspects of the economic balance sheet and associated risks.

Asset classes, as traditional units of analysis in asset allocation, are described along with their characteristics and the importance of homogeneity, exclusivity, diversification, and investable wealth coverage. The role of risk factors in asset allocation is noted, particularly in relation to systematic risk and expected return premiums.

The global market portfolio is introduced as a diversified baseline for asset-only allocation approaches. Passive and active management choices are explored both in strategic asset allocation and the implementation of asset class investments. Tactical and dynamic asset allocation, along with active and passive investment choices, are discussed as key dimensions in this context.

Risk budgeting is presented as a method for determining the types and amounts of risks to undertake, including the concept of active risk budgeting in relation to benchmark-relative risk. Rebalancing strategies, including calendar-based and range-based methods, are explained for aligning portfolio weights with strategic asset allocation, along with strategic considerations such as transaction costs, risk aversion, correlations, volatility, momentum beliefs, taxation, and liquidity.

Overall, this summary provides a comprehensive overview of the principles and practices of asset allocation, emphasizing governance, strategic planning, risk management, and implementation strategies in investment management.

This reading has introduced the subject of asset allocation. Among the points made are the following:

Effective investment governance ensures that decisions are made by individuals or groups with the necessary skills and capacity and involves articulating the long- and short-term objectives of the investment program; effectively allocating decision rights and responsibilities among the functional units in the governance hierarchy; taking account of their knowledge, capacity, time, and position on the governance hierarchy; specifying processes for developing and approving the investment policy statement, which will govern the day-to-day operation of the investment program; specifying processes for developing and approving the program’s strategic asset allocation; establishing a reporting framework to monitor the program’s progress toward the agreed-on goals and objectives; and periodically undertaking a governance audit.
The economic balance sheet includes non-financial assets and liabilities that can be relevant for choosing the best asset allocation for an investor’s financial portfolio.
The investment objectives of asset-only asset allocation approaches focus on the asset side of the economic balance sheet; approaches with a liability-relative orientation focus on funding liabilities; and goals-based approaches focus on achieving financial goals.
The risk concepts relevant to asset-only asset allocation approaches focus on asset risk; those of liability-relative asset allocation focus on risk in relation to paying liabilities; and a goals-based approach focuses on the probabilities of not achieving financial goals.
Asset classes are the traditional units of analysis in asset allocation and reflect systematic risks with varying degrees of overlap.
Assets within an asset class should be relatively homogeneous; asset classes should be mutually exclusive; asset classes should be diversifying; asset classes as a group should make up a preponderance of the world’s investable wealth; asset classes selected for investment should have the capacity to absorb a meaningful proportion of an investor’s portfolio.
Risk factors are associated with non-diversifiable (i.e., systematic) risk and are associated with an expected return premium. The price of an asset and/or asset class may reflect more than one risk factor, and complicated spread positions may be necessary to identify and isolate particular risk factors. Their use as units of analysis in asset allocation is driven by considerations of controlling systematic risk exposures.
The global market portfolio represents a highly diversified asset allocation that can serve as a baseline asset allocation in an asset-only approach.
There are two dimensions of passive/active choices. One dimension relates to the management of the strategic asset allocation itself—for example, whether to deviate from it tactically or not. The second dimension relates to passive and active implementation choices in investing the allocation to a given asset class. Tactical and dynamic asset allocation relate to the first dimension; active and passive choices for implementing allocations to asset classes relate to the second dimension.
Risk budgeting addresses the question of which types of risks to take and how much of each to take. Active risk budgeting addresses the question of how much benchmark-relative risk an investor is willing to take. At the level of the overall asset allocation, active risk can be defined relative to the strategic asset allocation benchmark. At the level of individual asset classes, active risk can be defined relative to the benchmark proxy.
Rebalancing is the discipline of adjusting portfolio weights to more closely align with the strategic asset allocation. Rebalancing approaches include calendar-based and range-based rebalancing. Calendar-based rebalancing rebalances the portfolio to target weights on a periodic basis. Range-based rebalancing sets rebalancing thresholds or trigger points around target weights. The ranges may be fixed width, percentage based, or volatility based. Range-based rebalancing permits tighter control of the asset mix compared with calendar rebalancing.
Strategic considerations in rebalancing include transaction costs, risk aversion, correlations among asset classes, volatility, and beliefs concerning momentum, taxation, and asset class liquidity.

PreviousREBALANCING: STRATEGIC CONSIDERATIONS NextQuestions (Asset Allocations)

Last updated 1 year ago

ChatGPT

This reading has introduced the subject of asset allocation. Among the points made are the following:

Effective investment governance ensures that decisions are made by individuals or groups with the necessary skills and capacity and involves articulating the long- and short-term objectives of the investment program; effectively allocating decision rights and responsibilities among the functional units in the governance hierarchy; taking account of their knowledge, capacity, time, and position on the governance hierarchy; specifying processes for developing and approving the investment policy statement, which will govern the day-to-day operation of the investment program; specifying processes for developing and approving the program’s strategic asset allocation; establishing a reporting framework to monitor the program’s progress toward the agreed-on goals and objectives; and periodically undertaking a governance audit.
The economic balance sheet includes non-financial assets and liabilities that can be relevant for choosing the best asset allocation for an investor’s financial portfolio.
The investment objectives of asset-only asset allocation approaches focus on the asset side of the economic balance sheet; approaches with a liability-relative orientation focus on funding liabilities; and goals-based approaches focus on achieving financial goals.
The risk concepts relevant to asset-only asset allocation approaches focus on asset risk; those of liability-relative asset allocation focus on risk in relation to paying liabilities; and a goals-based approach focuses on the probabilities of not achieving financial goals.
Asset classes are the traditional units of analysis in asset allocation and reflect systematic risks with varying degrees of overlap.
Assets within an asset class should be relatively homogeneous; asset classes should be mutually exclusive; asset classes should be diversifying; asset classes as a group should make up a preponderance of the world’s investable wealth; asset classes selected for investment should have the capacity to absorb a meaningful proportion of an investor’s portfolio.
Risk factors are associated with non-diversifiable (i.e., systematic) risk and are associated with an expected return premium. The price of an asset and/or asset class may reflect more than one risk factor, and complicated spread positions may be necessary to identify and isolate particular risk factors. Their use as units of analysis in asset allocation is driven by considerations of controlling systematic risk exposures.
The global market portfolio represents a highly diversified asset allocation that can serve as a baseline asset allocation in an asset-only approach.
There are two dimensions of passive/active choices. One dimension relates to the management of the strategic asset allocation itself—for example, whether to deviate from it tactically or not. The second dimension relates to passive and active implementation choices in investing the allocation to a given asset class. Tactical and dynamic asset allocation relate to the first dimension; active and passive choices for implementing allocations to asset classes relate to the second dimension.
Risk budgeting addresses the question of which types of risks to take and how much of each to take. Active risk budgeting addresses the question of how much benchmark-relative risk an investor is willing to take. At the level of the overall asset allocation, active risk can be defined relative to the strategic asset allocation benchmark. At the level of individual asset classes, active risk can be defined relative to the benchmark proxy.
Rebalancing is the discipline of adjusting portfolio weights to more closely align with the strategic asset allocation. Rebalancing approaches include calendar-based and range-based rebalancing. Calendar-based rebalancing rebalances the portfolio to target weights on a periodic basis. Range-based rebalancing sets rebalancing thresholds or trigger points around target weights. The ranges may be fixed width, percentage based, or volatility based. Range-based rebalancing permits tighter control of the asset mix compared with calendar rebalancing.
Strategic considerations in rebalancing include transaction costs, risk aversion, correlations among asset classes, volatility, and beliefs concerning momentum, taxation, and asset class liquidity.