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How to Incorporate Hedge Funds and Active Portfolio Management into an Asset Allocation Framework
... Modern Portfolio Theory recognizes only the market risk and seeks to minimize it through optimal asset allocation [Chabbra (2005)]. One of the most important decision which a manager or an advisor needs to make is to allocated funds across asset classes as asset allocation decision dictates the overall exposure to various systematic market risks and helps reducing it to a certain extent [Bein and Wander (2002)]. ...
... Also the increase in the popularity of indexed strategies also suggests a decrease in the expectations for active returns. Again the use of derivative instruments helps covering the systematic risk positions of the investors thus, minimizing the benefits of active asset allocation [Bein and Wander (2002)]. ...
A dissertation presented in part consideration for the degree of "MA Finance and Investments".
... Goldman, Sachs & Co. and Financial Risk Management Ltd. (1999) develop a topdown absolute-return framework emphasizing diversification across as well as within hedgefund strategies, with the primary constraint being the investor's ability to monitor multiple managers. Bein and Wander (2002) propose a top-down risk allocation framework that allows investors to explicitly integrate active management decisions and hedge-fund risks into a traditional overall asset allocation process. Chung, Rosenberg, and Tomeo (2004) provide another top-down hedge-fund asset allocation process by dividing hedge-fund strategies into two classes: convergent strategies that benefit from small temporary mispricings, which are short volatility, and divergent strategies that exploit larger and longer-horizon market inefficiencies, which are long volatility. ...
The hedge-fund industry has grown rapidly over the past two decades, offering investors unique investment opportunities that often reflect more complex risk exposures than those of traditional investments. In this
article we present a selective review of the recent academic literature on hedge funds as well as updated empirical results for this industry. Our review is written from several distinct perspectives: the investor's, the
portfolio manager's, the regulator's, and the academic's. Each of these perspectives offers a different set of insights into the financial system, and the combination provides surprisingly rich implications for the
Efficient Markets Hypothesis, investment management, systemic risk, financial regulation, and other aspects of financial theory and practice.
The author starts by observing that new attempts to create an investable hedge funds index are several. Yet, in this article, he shows that, in spite of these serious efforts, the hedge funds universe lacks the elements necessary to construct an investable index that can be used as a passive hedge fund investment vehicle. He concludes that hedge funds do not meet the tests for an asset class and do not fit into any of the classifications of asset classes proposed by Greer [1997].
Does asset allocation policy explain 40 percent, 90 percent, or 100 percent of performance? According to some well-known studies, more than 90 percent of the variability of a typical plan sponsor's performance over time is attributable to asset allocation. However, few people want to explain variability over time. Instead, an analyst might want to know how important it is in explaining the differences in return from one fund to another, or what percentage of the level of a typical fund's return is the result of asset allocation. To address these aspects of the role of asset allocation policy, we investigated these three questions. 1. How much of the variability of returns across time is explained by asset allocation policy? 2. How much of the variation of returns among funds is explained by differences in asset allocation policy? 3. What portion of the return level is explained by returns to asset allocation policy? We examined 10 years of monthly returns to 94 balanced mutual funds and 5 years of quarterly returns to 58 pension funds. For the mutual funds, we used return-based style analysis for the entire 120-month period to estimate policy weights for each fund. We carried out the same type of analysis on quarterly returns of 58 pension funds for the five-year 1993-97 period. For the pension funds, rather than estimated policy weights, we used the actual policy weights and asset-class benchmarks of the pension funds. We answered the three questions as follows: In summary, our analysis shows that asset allocation explains about 90 percent of the variability of a fund's returns over time but explains only about 40 percent of the variation of returns among funds. Furthermore, on average across funds, asset allocation policy explains slightly more than 100 percent of the levels of returns. Thus, the answer to the question of whether asset allocation policy explains 40 percent, 90 percent, 100 percent of performance, depends on how the question is interpreted.
The author explores the issue of asset location, focusing more specifically on the long run return and risk implications of using fewer or more asset locations. The article is structured in the form of a case study, which first introduces a hypothetical wealthy family and then discusses the various holding structures from which the family may select to achieve their investment goals more effectively. The author presents three possible solutions, comprising one, three and seven individual locations, identifying the principal portfolio composition differences and their implication on expected investment characteristics. The article illustrates the importance of a careful analysis of the various location options, showing that the seven-location portfolio provides both higher expected after-tax returns, lower volatility and lower initial portfolio diversification costs. The author concludes with a brief discussion of the concept of dynamic asset location, which allows an investor to enhance the tax-efficiency...
In order to delineate investment responsibility and measure performance contribution, pension plan sponsors and investment managers need a clear and relevant method of attributing returns to those activities that compose the investment management process—investment policy, market timing, and security selection. The authors provide a simple framework based on a passive, benchmark portfolio representing the plan's long-term asset classes, weighted by their long-term allocations. Returns on this "investment policy" portfolio are compared with the actual returns resulting from the combination of investment policy plus market timing (over- or underweighting within an asset class). Data from 91 large U.S. pension plans over the 1974-83 period indicate that investment policy dominates investment strategy (market timing and security selection), explaining on average 95.6 percent of the variation in total plan return. The actual mean average total return on the portfolio over the period was 9.01 percent, versus 10...
Using the fortuitous confluence of two events, the 50th anniversary of the publication of Harry Markowitz' seminal paper on mean-variance optimization and the 100th anniversary of Lord Kelvin's articulation of the atomic model (launching what we now know as quantum mechanics), the author examines selected limits to the usefulness of Modern Portfolio Theory and draws conclusions as to areas where other approaches are as likely as MPT to provide helpful insights to investors. The article starts with a review of the critical assumptions underpinning MPT and then reviews implications on important decisions such as the classification of asset classes, the use of anchor to windward in individual portfolios, the role and use of hedge funds, real estate, or hard assets, and the redefinition of risk. It concludes that a thorough understanding of the assumptions underpinning any tool or process is critical to ensure the usefulness of the model's recommendations and suggests that there are significant limits to the ...
Asset Location-The Critical Variable: A Case Study
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The Journal of Wealth Management, Summer 2001, pp. 27-43.
Integrated Wealth Management: The New Direction for Portfolio Managers
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The Journal of Private Portfolio Management
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The Role of Alternative Assets in Tax-Efficient Portfolio Construction
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1999b, pp. 9-26.