College aantekeningen
Lecture notes
Lecture notes of all lectures of the FAIB course.
[Meer zien]Voorbeeld 4 van de 143 pagina's
Voorbeeld 4 van de 143 pagina's
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Voorbeeld van de inhoud
Hoorcollege 1 29-01-2018Most important decision: long-term investment portfolio (investment fund). The long-term investment
portfolio is about asset classes, not about individual stocks.
Tactical asset allocation Deviate from the usual long-term asset allocation. The 60/40 (equity/bonds)
long-term portfolio is often used as optimal portfolio, but one can deviate from
this. This deviation is called tactical asset allocation.
Factor investing Investing by choosing stocks on attributes that are associated with higher returns
Example factor investing: Say you want equity exposure. CAPM says that you should invest in a
tracker on MSCI world. This is very diversified across markets and across firms. This would be your
natural benchmark. An alternative would be to form a portfolio of factors. If you invest in the market
portfolio, you will earn the market risk premium. The Fama-French model tells us, however, that we
can earn an additional risk premium by being in value stocks, small stocks, stock with momentum, et
cetera. There are different factors which you can be compensated for. So, why should we instead of
holding MSCI world, not hold a portfolio that allow us to earn part of the different risk premium.
Black-Litterman model model that allows us to incorporate views. We start from the base situation (40
percent bonds, 60 percent equity). The different views come with different
tactical asset allocations.
Case 1: Harvard Management Company
The first case Harvard Management Company and Inflation-Linked Bonds deals with the strategic asset
allocation decision.
Strategic asset allocation How to set long-term, strategic allocation to different asset classes, such as
equities, bonds, or alternatives.
Case 2: BP Amoco
The second case The Harmonized Savings Plan at BP Amoco discusses the implementation of the
strategic asset allocation:
1. Active versus passive funds
2. Active funds selection
3. Funds versus individual stocks, bonds, …
4. Role of costs
But also:
1. How should allocation be different across individuals?
2. How does time to retirement affect the allocation over the life cycle?
Due to the merger of BP and Amoco, also their pension plans had to merge. However, their pension
plans were structured in completely different ways. We are going to look at this and learn what the
perfect merged pension plan should look like.
Asset allocation tools
We will discuss two popular quantitative asset allocation tools:
1. Black-Litterman model
2. Parametric Portfolio Policy
, Black-Litterman model Combines market-neutral expected returns with views.
Parametric Portfolio Policy Asset characteristics determine active weights
Factor investing
Investors should ‘harvest risk premiums’ by investing in:
1. Value stocks
2. Small stocks
3. Stocks with positive momentum
4. High quality stocks (high profitability, low leverage, predictable earnings)
5. Low beta/low volatility stocks
6. Less liquid stocks
Some of these premiums are compensated for risks; others are likely the result of some systematic
behavioral biases.
Harvard Management Company and Inflation-Linked Bonds
Harvard Management Company manages the endowment fund of Harvard University. In 2000, the total
assets under managements was US$19 billion (in 2018: US$37 billion). 68 percent is managed
internally, 32 percent by outside asset managers. So, part of the assets (money) is outsourced to
investment banks.
Endowment fund Successful alumni of Harvard give donations to the university. Basically, this
money is put into an account that is managed. Not all this money is used directly,
so part is put in an endowment (can be seen as a portfolio).
This endowment is important for the university, since it can be seen as dividend to the university. This
dividend can be used for many purposes (hiring new professors, investing in innovative teaching
technology).
Harvard Management Company
Income from the endowment fund is important to the different schools (25%, compared to 30 percent
from tuition fees). Real return growth objective between 6% – 7%.
Annual distribution: 4% – 5%
– income (gifts) 1%
+ real spending growth 3%
Target real return 6% – 7%
Their strategic asset allocation should help them accomplish the real return growth of 6 to 7 percent.
The endowment funds are crucially for the functioning of Harvard. Due to these endowment funds,
Harvard can have the best teachers et cetera. The target real return of the endowment fund is 6 percent
to 7 percent. Annual distribution of the fund is 4 to 5 percent. Harvard also does get gifts, which is
approximately 1 percent of the fund. We need to find an asset allocation that is at minimal risk yielding
6 to 7 percent a year. That is the task of the strategic asset allocation.
,Strategic asset allocation
What is the role of the policy portfolio for HMC?
1. Long-run (or ‘strategic’) asset allocation of the endowment over main asset classes
2. Benchmark for performance measurement: endowment, managers
3. How is the policy determined? Quantitative techniques
Strategic asset allocation
Optimal portfolio weights If we invest in assets according to these weights, we should reach our objective.
The first step is always determining what is our objective. In the Harvard case, the objective is 6 to 7
percent return and minimum risk. The optimal portfolio weights should help us reach our target. We
implicitly assume a mean-variance utility function. Second, we need to determine what asset classes we
are going to invest in (alternative assets, specific classes of assets, equity, bonds). Once you have asset
classes, you need to make assumptions (ER, volatility, correlation).
Strategic asset allocation
Different steps:
1. Objective function specification (utility function)
2. Specify asset classes
3. Capital market assumptions (ER, volatility, correlation)
4. Optimization
Step 1 – 4: use mean-variance analysis
5. Backtesting – simulation
6. Implementation (portfolio manager selection)
7. Follow up (performance measurement)
Assumptions What is expected return on the assets? What is the volatility and correlation?
Backtesting Assume that you implemented this strategy 10 years ago and go through different stress years.
Follow up Once your strategy is in place, you have to follow it and measure performance
, HMC: current policy portfolio
This is the strategic asset allocation (line: policy portfolio) of Harvard Business case. The minimum and
maximum columns tell us the bounds that the asset managers can deviate from the policy portfolio. The
policy portfolio is 32 percent in the domestic equity, but it can range from 22 to 42 percent (but no more
or no less). The striking thing is the negative cash. By default, they lever up their portfolio by 5 percent.
They could lever up till 10 percent. Is this a risky portfolio? The portfolio is 71 percent in equity. They
thus go for quite an aggressive strategy. Do the assets included in this asset allocation make sense? (see
next slides).
Note: private equity belongs to equity. The portfolio is 71 percent in equity. The absolute returns
represent hedge funds. Hedge funds can go short: if the market goes down, they short the market; if the
market goes up, they long the market.
Portfolio building blocks: some rules
1. Do not neglect equities
2. Diversify across many stocks
3. Diversify internationally, including emerging and frontier markets
4. Diversify across alternative asset classes
5. Factors matter, not assets
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