Reverse Asset Allocation: Alternatives At The Core,

Reverse Asset Allocation: Alternatives At The Core

By P. Brett Hammond

INTRODUCTION
Institutional investors have shown an increasing interest in alternative asset classes—including private equity, venture capital, real estate, commodities, hedge funds, and others—due to their strong performance and low correlations with traditional assets. In addition, diminished expectations for returns from traditional assets have made alternative assets even more attractive. The inclusion of alternatives in formal asset allocation models, however, can make these models highly sensitive to small changes in a portfolio’s allocations. Moreover, because most alternatives do not have long track records, some institutions may be unsure how to predict the risk/return behavior of these investments in a traditional asset allocation model. A new approach—“reverse asset allocation”—addresses these challenges by taking into account the special characteristics of alternative assets. Unlike traditional asset allocation, which, to produce the bulk of overall return, puts equities at the core of the portfolio and then, to limit risk and improve efficiency, adds bonds plus alternatives, reverse asset allocation does the opposite. It begins by finding the expected return from a desired allocation to a core group of alternative assets, and then adds bonds and equities as the completion elements, to achieve the overall desired portfolio characteristics. The rationale for reversing the usual approach is based on the notion that alternatives offer an opportunity to obtain asset-based return alpha with low correlation to traditional asset classes while limiting risk.

A Closer Look at Stable Value Funds Performance

A Closer Look At Stable Value Funds Performance

Babbel, David F. and Herce, Miguel,(September 18, 2007). Wharton Financial Institutions Center Working Paper #07-21

Abstract

There exists a paucity of academic literature on stable value (SV) funds, although a growing volume of industry and practitioner literature has provided an in-depth look at how the funds are managed and the guarantees secured. To date, no rigorous analysis has been published on the performance of stable value funds from the investor's point of view. In this study, we provide what we understand to be the first published analysis of the performance of stable value funds

The Stock–REIT Relationship and Optimal Asset Allocations

The Stock–REIT Relationship and Optimal Asset Allocations

Doug Waggle, and Pankaj Agrrawal, Journal of Real Estate Portfolio Management, (Volume 12, Number 3, 2006)

Executive Summary.

In this paper, the marginal effects of changes (due to non-stationarity or estimation errors) in the REIT-stock risk premium and the REIT-stock correlation on the optimal portfolio asset mix of REITs, stocks, and bonds are determined. Employing a meanvariance utility function and considering different levels of investor risk aversion, the findings reveal that the expected return of REITs, relative to that of stocks, is a much more important factor than the REIT-stock correlation in making portfolio decisions. A 1% change in the forecast return for REITs dramatically impacts optimal portfolio allocations for investors of all risk levels. A significant change of 0.1 in the REIT-stock correlation, on the other hand, has only minimal impact on optimal portfolio weights.

Securitized Real Estate and its Link With Financial Assets and Real Estate: An International Analysis

Hoesli, Martin and Serrano Moreno, Camilo, (April 2006)

Abstract:

This paper provides cross-country evidence of the link between securitized real estate and stocks, bonds, and direct real estate. First, we investigate the behavior of betas in 16 countries and identify the causes of their variation. Second, securitized real estate returns are regressed on "pure" stock, bond and real estate factors. The betas are generally found to decrease over the 1990-2004 period, but the causes for such decline differ across countries. Securitized real estate returns are found to be positively associated with stock and direct real estate returns, but negatively related to bond returns. Financial assets contribute greatly to the variance of securitized real estate, while the impact of direct real estate is limited. However, a large fraction of the variance is not accounted for by these factors, especially in the U.S., suggesting that other factors are at play.

Rebalancing for Taxable Accounts

Rebalancing for Taxable Accounts

Mark W. Riepe, CFA, and Bill Swerbenski, CFA (JFP Journal, April 2007)

Tips When Rebalancing in a Taxable Account

1. Exert more care when rebalancing in taxable accounts.
2. Avoid generating rebalancing trades by directing new money into underweighted asset classes.
3. When sensible, execute trades to generate tax losses that can then be used to offset any capital gains generated by
rebalancing trades.
4. Be patient and wait until eligible for long-term capital gains treatment.
5. If taxable and tax-deferred accounts are both allocated toward the same goal, have the tax-deferred account bear as much of the
rebalancing load as possible.

Is Rebalancing a Portfolio During Retirement Necessary?

Is Rebalancing a Portfolio During Retirement Necessary?

John J. Spitzer, Ph.D., and Sandeep Singh, Ph.D., CFA, (JFP Journal, June 2007)

This paper investigates the strategy of rebalancing the retirement portfolio during the withdrawal phase.The goal is to provide the largest number of equal (real) withdrawals from a given retirement portfolio.

• The study investigates six different allocations of stock and five different harvesting rules, only one of which rebalances the portfolio annually.The methods are tested using five different withdrawals rates (3–7 percent).The results look at shortfalls over 30 years, as well as shorter periods.
• The study uses two analysis methods: bootstrap and historical inflation adjusted rates of return in their true temporal order. Both methods find that rebalancing provides no significant protection on portfolio longevity, and this holds for all withdrawal periods. In fact, in some cases, rebalancing increases the number of shortfalls.
• Withdrawing bonds first, over stocks, performs the best of all the methods, though the resulting stock-heavy portfolio may make some investors uneasy. This method also is most apt to leave a larger remaining balance at the end of 30 years, while rebalancing leaves the smallest amount.
• Withdrawing stocks first leaves more shortfalls than withdrawing low first or high first.
• Confirming previous research, the larger the proportion of stocks to bonds, the longer the portfolio lasts; the higher the withdrawal rate, the more shortfalls.
• The results suggest that the use of lifecycle funds or a life-cycle strategy that decreases stock proportions as one grows older needs empirical justification.