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Asset Allocation. Why Dynamic Asset Allocation is winning the race? Arnaud de Servigny. A review of the current Asset Allocation paradigm . Modern Portfolio Theory R.I.P.!.
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Asset Allocation WhyDynamicAsset Allocation iswinning the race? Arnaud de Servigny
A review of the currentAsset Allocation paradigm. Modern Portfolio Theory R.I.P.!
On The Efficient Frontier, there is a high degree of certainty and therefore a high degree of concentration!
The efficient frontierusually relies on a limitednumber of support assets
There is verylittleyear on yearstability of the Efficient Frontier
Out-of-sample, the efficient frontierusually drifts to much more modest & sub-optimal performance
Over the past 20 years there has been a trend of growing out-of-sampleunder performance of the MPT
The Market portfolio (CAPM) & the MPT portfolios are equally not doing well
Whydoesn’titwork? There is no variance stability of main asset classes! 1 The critical values for the 90%, 95% and 99% level tests are respectively below 1.22, 1.36 and 1.63, for an rejection (21”0 of no break.
A test to see if we face a fat tail problem or a regime switching problem?
« Through the cycle » correlation and covariance do not exist!
Out-of-sample performance of a 3 asset Regime Switching model
An “all weather” mean-variance optimisation fails to capture regime changes and therefore fat tails & the dynamics of fat tails Regime 2 Growth “Through the Cycle “ Average Fat tailed “through the cycle” distribution Regime 1 Recession Time
An Unknown complex multi-regime environment can be approximated by a regularly re-estimated Mean-Variance framework updated with latest information (EWMA estimation) EWMA Estimation of monthly mean / covariance matrix Monthly mean variance process Regime 2 Growth Regime 1 Recession Time Unit of time delta ( t) Unit of time delta ( t) Unit of time delta ( t) Unit of time delta ( t) Unit of time delta ( t) Unit of time delta ( t)
A Case Study • A full out-of-sampleAnalysis • In one case 4 asset classes (CashTB,IG Bond,HY Bond,US Equity ), in the other 9 (CashTB,Gov Bond,IG Bond,HY Bond,DevEquity,EM Equity,Commodities,Real Estate,HedgeFunds) • Thetargetedvolatilitylevel in the portfolio is 8% • 4 methodologies: • Equallyweighted • Mean-Variancereestimatedeveryyearbasedon a 10-year slidingwindow • Mean-Variancereestimatedeveryyearusing a memorydecayestimationmethod (EWMA) • Mean-Variancereestimatedeverymonthusing a memorydecayestimationtechnique (EWMA)
What is the truelevel of asset diversification in eachapproach?
Market Prices: Long-term results Data as of 20.06.2012