strategic asset allocation reading

Question 1

strategic asset allocation

Answer 1

an asset allocation that arises in long-term investing planning

asset allocation that is expected to be effective in a achieving an asset owner’s investment objectives

–> respects constraints and risk tolerance

often considered the most important activity of the investment process

Question 2

utility theory

Answer 2

utility that represents investor’s preferences based on risk and return

the optimal asset allocation is the one that is expected to prive the highest utility to the investor at his time horizon

Question 3

steps to strategic asset allocation

Answer 3

1. determine and quantify the investor’s objectives
2. determine risk tolerance and how risk should be expressed and measured
3. determine the investment time horizon
4. determine other constraints and the requirements they impose on asset allocation choices
5. determine the approach to asset allocation that is most suitable to the investor
6. specify asset classes, and develop a set of capital market expectations for the specified asset classes
7. develop a range of potential asset allocation choices for consideration
8. test robustness of potential choices
9. iterate back to step 7 until an appropriate and agreed-on asset allocation is constructed

Question 4

when do we do the strategic asset allocation decision?

Answer 4

after the formation fo the capital market expectations

Question 5

three major approaches to asset allocation

Answer 5

asset only

liability relative

goal based

Question 6

asset only AA

Answer 6

focus solely on the asset side of the investor’s balance sheet

–> liabilities not explicitly modeled

Question 7

most familiar and studied asset only AA approach

Answer 7

mean-variance optimization (MVO)

Question 8

mean-variance optimization (MVO)

Answer 8

asset only approach

only considers expected returns, risks, and correlations between assets

Question 9

liability relative AA approach

Answer 9

explicitly account for the liabilities side of the balance sheet

–> dedicates asset allocation to meet these

we need money to provide liabilities when they come due

Question 10

liability-driven investing (LDI)

Answer 10

term that encompasses asset allocation focused on funding an investor’s liabilities

focus on the risk of having insufficient assets to pay obligations when due

Question 11

goals-based AA approach

Answer 11

explicitly account for the liabilities side of the balance sheet

we need to specify asset allocations for sub-portfolios. each of which is aligned to specified goals ranging from supporting lifestyles needs to aspirational

each goal is associated with regular, irregular, or bulleted cash flows; a distinct time horizon; and a risk tolerance level expressed asa. required probability of achieving that goal

Question 12

who are the primary users of the goals-based AA approach?

Answer 12

families and individuals

Question 13

goals-based investing

Answer 13

investment industry term that encompasses the asset allocation focused on addressing investor’s goals

focus on the risk of failing to achieve goals

Question 14

distinctions between liabilities for an institutional investor and goals for an individual investor

Answer 14

1. liabilities of institutional investors are legal obligations or debts

–> goals are not obligations, hence failing to meet them does not trigger the same consequences

2. institutional liabilities are uniform in nature

–> individuals’ goals may be many and varied

3. liabilities of institutional investors of a given type are often numerous and may be forecast with accuracy through averaging

–> goals are more uncertain