Chapter 18 Flashcards
Asset Allocation Process
- Determine the SAA
- Rebalance the portfolio
- formulate a tactical asset allocation strategy (optional)
Performance attribution
returns are explained in terms of the relative contributions of asset allocation and security selection
Debt securities characteristics
- Term to maturity
- credit quality
- structure (i.e. convertible, preferred, etc.)
- geography
Equity Securities Classifications
- capitalization
- geography
- style (value or growth)
Asset Location
refers to the placement of assets in taxable, tax-deferred, and tax-exempt accounts to achieve the greatest after-tax return for a given risk tolerance
Where should debt securities that generate interest income be held?
In a tax deferred or exempt account
Where should equity securities that generate dividends or capital gains be held?
In a taxable account
Two factors for an appropriate SAA
- the clients investment objectives
- capital market expectations
Two factors affecting capital market expectations
- past performance
- professional judgement
Mean variance optimization
Procedure devised by the American economic Harry Markowitz to identify the efficient frontier from a set of asset class returns, standard deviations, and correlations
Three Methods to Design an SAA
- mean variance optimization
- rule of thumb
- ad hoc
Rule of Thumb
Based on time diversification, under this principle, above average returns tend to offset below average returns over time, so that the annualized standard deviation of an investment diminishes (life cycle approach or age approach)
Life Cycle Approach
categorizes investors by different life cycles based on their age and characteristics (early earning years, mid-earning years, peak earning years, retirement)
Age Approach
more specific than life cycle approach because it is based on the client’s specific age: allocation to equities = 100 - client’s age
Ad Hoc Approach
SAA is based simply on the advisor’s opinion or instinct (not recommended)
Two approaches to rebalancing
Calendar rebalancing
Weight based rebalancing
Corridor Width
the trading band within which the market value of each asset class can fluctuate without having to be rebalanced
Two opposing Strategies of Tactical Asset Allocation
Counter-trend strategy
Momentum strategy
Counter-trend strategy
Directs investments toward asset classes that have recently underperformed and away from those that have outperformed, with the expectation that the trend will change
Momentum Strategy
Tilts the portfolio toward asset classes that have recently outperformed with the expectation that they will continue to do so
Valuation Based Approach
Entails identifying an inexpensive or expensive asset class by comparing the current and prospective value of an asset class relative to other asset classes (look at risk premium)
Cyclical Based Approaches
Involves monitoring economic and business cycles and looking for patterns that have historically led to rises and fall in the stock and bond markets
Factors that influence economic and business cycles
- shape of yield curve
- monetary and fiscal policy
- taxation policy and levels
- inflation
- corporate profits
- market valuations
