Wednesday, July 25, 2007

Analysis of the Investment Potential and Inflation-Hedging Ability of Precious Metals

Analysis of the Investment Potential and Inflation-Hedging Ability of Precious Metals

McCown, James Ross and Zimmerman, John R., (July 23, 2007).

Gold and silver show strong evidence of ability to hedge stock portfolios and inflation during the period from 1970 to 2006. However, negative betas are only observed for the 1970s, suggesting that it is the inflation-hedging ability that is the cause of the stock-hedging ability. Both metals show high correlation with expected future inflation as measured by the TIPS spreads, confirming Greenspan's (1993) conjecture that gold prices are an indicator of expected inflation.

Note: This post has been added to Asset Class Reader:Gold

Tuesday, July 24, 2007

Lifetime Financial Advice: Human Capital, Asset Allocation, and Insurance

Lifetime Financial Advice: Human Capital, Asset Allocation, and Insurance

Roger G. Ibbotson, Moshe A. Milevsky, Peng Chen, CFA, and Kevin X. Zhe (2007)

We can generally categorize a person’s life into three financial stages. The first stage is the growing up and getting educated stage. The second stage is the working part of a person’s life, and the final stage is retirement. This monograph focuses on the working and the retirement stages of a person’s life because these are the two stages when an individual is part of the economy and an investor. Even though this monograph is not really about the growing up and getting educated stage, this is a critical stage for everyone. The education and skills that we build over this first stage of our lives not only determine who we are but also provide us with a capacity to earn income or wages for the remainder of our lives. This earning power we call “human capital,” and we define it as the present value of the anticipated earnings over one’s remaining lifetime. The evidence is strong that the amount of education one receives is highly correlated with the present value of earning power. Education can be thought of as an investment in human capital. One focus of this monograph is on how human capital interacts with financial capital. Understanding this interaction helps us to create, manage, protect, bequest, and especially, appropriately consume our financial resources over our lifetimes. In particular, we propose ways to optimally manage our stock, bond, and so on, asset allocations with various types of insurance products. Along the way, we provide models that potentially enable individuals to customize their financial decision making to their own special circumstances.

Wednesday, July 11, 2007

A Primer on Tactical Asset Allocation

The following Vanguard Institutional Paper examines the risks and rewards of Tactical Asset Allocation. Some definitions are in order (courtesy of investopedia):

Strategic Asset Allocation:
What does it Mean? A portfolio strategy that involves periodically rebalancing the portfolio in order to maintain a long-term goal for asset allocation.

Investopedia Says... At the inception of the portfolio, a "base policy mix" is established based on expected returns. Because the value of assets can change given market conditions, the portfolio constantly needs to be re-adjusted to meet the policy

Tactical Asset Allocation:
What does it Mean? An active management portfolio strategy that rebalances the percentage of assets held in various categories in order to take advantage of market pricing anomalies or strong market sectors.

Investopedia Says... This strategy allows portfolio managers to create extra value by taking advantage of certain situations in the marketplace. It is as a moderately active strategy since managers return to the portfolio's original strategic asset mix when desired short-term profits are achieved.

A Primer on Tactical Asset Allocation

Yesim Tokat, Ph.D.
Kimberly A. Stockton

Many pension funds, endowment funds, and other institutional investors are concerned that equities—typically their largest asset allocation—will have lower average returns over the next decade. In this environment, many investors have questioned the wisdom of thinking about asset allocation solely in strategic terms and have shown renewed interest in tactical approaches. Tactical asset allocation (TAA) is a dynamic strategy that actively adjusts a portfolio’s strategic asset allocation (SAA) based on short-term market forecasts. Its objective is to systematically exploit inefficiencies or temporary imbalances in equilibrium values among different asset or subasset classes. Over time, strategic long-term target allocations are the most important determinant of total return for a broadly diversified portfolio. TAA can add value at the margin, if designed with the appropriate rigor to overcome significant risk factors and obstacles unique to the strategy. Our results show that while some TAA strategies have added value, on average TAA strategies have not produced statistically significant excess returns over all time periods. This raises several important questions for institutional investors: What tools and processes do they need to have in place to make optimal decisions regarding TAA strategies? What are the right questions to ask a prospective manager? What are the critical components of a good model if they choose to run a TAA strategy in-house? This paper provides answers to these questions.