R12: Overview Of Asset Allocation

Question 1

What are the differences between strategic and tactical AA?

Answer 1

Strategic: LT (more than 5 years), desired exposure to systematic risk factors.

Tactical: active, exploit market inefficiencies.

Question 2

What are the three asset allocation styles?

Answer 2

Asset-only:
Focus on risk-adjusted return of assets, MVO, standard deviation, downside risk, TE

Liability-relative:
Optimises AA in relation to meeting liabilities, surplus optimisation, shortfall risk, relative duration of assets vs liabilities

Goals-based:
Focuses on meeting individual goals with specified probability of success, funding expenses and needs, probability of not achieving goal

Question 3

Characteristics of a well-defined asset class?

Answer 3

Homogenous
Mutually exclusive 
Diversifying
Investable and absorbs meaningful proportion of investor's portfolio
Together, cover the investment universe

Question 4

What are the superclasses?

Answer 4

Capital
Consumable/transferable
Store of value

Question 5

What’s dynamic AA?

Answer 5

Form of tactical, motivated by longer term valuation signals or economic views

Question 6

What are the two main methods of rebalancing to strategic weights?

Answer 6

1. Calendar rebalancing

2. Percent-range rebalancing

Question 7

For percentage-range rebalancing, when would the ranges be wider with respect to transaction costs, correlation of investments, belief in momentum, risk aversion, volatility of rest of portfolio, mean-reverting?

Answer 7

Wider ranges if higher TCS, higher correlation of investments, higher belief in momentum, lower risk aversion, lower volatility of rest of portfolio, if not mean-reverting

Question 8

What is a decision-reversal risk?

Answer 8

When the course of action is reversed at the worst possible time