In rebalancing, securities within a portfolio are adjusted based on their relative weights. Disciplined rebalancing tends to reduce risk while incrementally adding to returns. Interpretations of this empirical finding include the following: Rebalancing earns a diversification return, in that rebalancing…

Heuristics, also known as rules of thumb, are simplistic and generic rules that investors use to satisfice. Satisficing, as covered in the behavioral economics section, reflects an attempt to reach a satisfactory economic decision at the expense of an optimal…

A goals-based asset allocation process combines into an overall portfolio numerous sub-portfolios, each designed to fund a single goal within its time horizon and required probability of success. Individuals have unique needs that differ from those of institutions. The critical…

Liability-relative approaches first view the cash flows of the sponsoring organization in question and then attempt to build a portfolio of securities that will satisfy these payments as they come due. This is in contrast to the popular asset-only approach…

Liability-relative approaches first view the cash flows of the sponsoring organization in question and then attempt to build a portfolio of securities that will satisfy these payments as they come due. This is in contrast to the popular asset-only approach…

Aside from the well-known asset-only approach to asset allocation, other options are available to financial professionals. Another lens to view asset allocation involves thinking not of an already constructed portfolio of assets but first viewing the liabilities under the portfolio’s…

Until this point in the curriculum, risk has been looked at through an asset class perspective, answering the question, ‘What risks are inherent in each asset class?’ Switching to a new paradigm, portfolios may be constructed when viewing risk not…

Client needs, and preferences would seem to be a qualitative factor. How, then, would an analyst include these factors into the quantitative models required to analyze a portfolio from the perspective of modern portfolio theory? The following three approaches are…

Risk budgeting is a means of making optimal use of risk to pursue return. A risk budget is optimal when the ratio of excess return to marginal contribution to total risk (MCTR) is the same for all assets in the…

The problem of illiquid assets complicates traditional asset allocation. Some of the most prominent investments in this category include direct real estate, infrastructure, private equity, and hedge funds. Illiquidity and Lack of Investable Index Illiquid assets represent those for which…