2006

November 3, 2006

These portfolios by no means attempt to find the ideal asset allocation for everyone. Depending on your financial situation, the weightings of the assets could be very different. I am simply using these as a standard in order to compare the alternative portfolios.

World Beta 5 Asset Class Portfolio
25% US Stocks (VTI)
25% Foreign Stocks (EFA)
30% US Bonds (AGG)
10% Real Estate (VNQ)
10% Commodities (GSP)
100%

The risk parity portfolio simply uses the extra capital freed up from leverage to place more money into bonds. . .

World Beta 5 Asset Class Risk Parity Portfolio
25% US Stocks (ULPIX) ie only allocate 12.5% of funds to ULPIX as it is 2:1 leveraged
25% Foreign Stocks (UNPIX) ditto
55% US Bonds (AGG)
10% Real Estate (VNQ)
10% Commodities (GSP)
125%

In this case, the extra capital is allocated to portable alpha.

World Beta 5 Asset Class Portable Alpha Portfolio
25% US Stocks (ULPIX) ie only allocate 12.5% of funds to ULPIX as it is 2:1 leveraged
25% Foreign Stocks (UNPIX) ditto
30% US Bonds (AGG)
10% Real Estate (VNQ)
10% Commodities (GSP)
25% World Alpha (10 Holdings)
125%

And just to show how larger portfolios of world betas might look, 10 & 20 holdings:

World Beta 10 Asset Class Portfolio
12.5% US Large Cap (IWD)
12.5% US Small Cap (BRAIX)
12.5% Foreign Developed (EFA)
12.5% Foreign Emerging (EEM)
7.5% US Govt Bonds (1-3) (SHY)
7.5% TIPS (TIP)
7.5% Foreign Bonds (unhedged) (PFBDX)
7.5% Emerging Bonds (FNMIX)
10% Real Estate (VNQ)
10% Commodities (GSP)
100%

World Beta 20 Asset Class Portfolio
7.5% US Large Cap (IWD)
7.5% US Small Cap (BRAIX)
5% US Micro Cap (PZI)
5% Private Equity (PSP)
10% Foreign Developed (VHGEX)
7.5% Foreign Small Cap (RISIX)
7.5% Foreign Emerging (EEM)
4% US Govt Bonds (1-3) (SHY)
4% Bank Loans (FFRHX)
4% Mortgage (TGLMX)
4% Municipals (FTABX)
3% TIPS (TIP)
3% High Yield Corporate (VWEHX)
4% Foreign Bonds (unhedged) (PFBDX)
4% Emerging Bonds (FNMIX)
5% Real Estate (VNQ)
5% International Real Estate (RMR)
2% Timber (PCL)
2% Precious Metals (GLD)
6% Commodities (GSP)
100%

And lastly, a 50/50 allocation to World Beta 20 and World Alpha.
World Beta 20 and World Alpha
100%

Improvements to Standard Asset Allocation

November 3, 2006

The academic literature has found a number of adjustments an investor can make to improve upon the typical standard US Stocks & US Bonds allocation. In no particular order they are:

1. Tilt the portfolio to value. (And tilt toward fundamental weightings)
2. Tilt the portfolio to smaller companies.
3. Add foreign and emerging equities.
4. Add various types of bonds, ie TIPS, foreign, high yield, etc.
5. Prefer low duration government bonds vs. long duration.
6. Add uncorrelated real asset classes such as commodities, REITs, timber, etc.

Diversification & Tracking Portfolios Beginning 12/31/2006

November 1, 2006

True diversification means moving outside of the typical US Equities and US Bonds to other asset classes. A simple 5 asset class portfolio could consist of :

US Stocks (VTI)
Foreign Stocks (EFA)
US Bonds (AGG)
REITs (IYR)
Commodities (GSP)

An investor looking to add more asset classes could easily approach 15-20 worldwide betas. In this blog, starting Dec 31, 2006 I will track a number of World Beta Portfolios. They will include:

World Beta 5 Asset Class
World Beta 5 Asset Class Risk Parity
World Beta 5 Asset Class Portable Alpha (From the World Alpha ports)

World Beta 10 Asset Class

World Beta 20 Asset Class
World Beta 20 + World Alpha (50% in each)

Risk Parity

November 1, 2006

Let’s take a look at a way to practically implement risk-parity in a portfolio. A traditional 60/40 mix of stocks and bonds can be leveraged one of three ways. First, through a traditional margin account with the investor being charged the broker call rate + or – an amount relative to their account size. Currently the rate at Fidelity is 6% for balances > $500k, but can approach 10% for smaller balances. . .

A second option would be to use the leveraged mutual funds. Say an investor has the following allocation:

60% SPY (S&P 500 ETF)
40% AGG (Lehman Aggregate Bond ETF)

The investor could then leverage the portfolio to whatever target he desires. For example

60% SPY
70% AGG

for a total of 130% invested. Likewise he could use the Rydex or ProFunds leveraged funds to achieve the risk parity.

30% ULPIX (Essentially 60% Large Cap exposure)
70% AGG

Do to the nuances of how Rydex and ProFunds leverage their portfolios (they attempt to achieve 2:1 on a daily basis) there will be a difference in overall performance.

Third, an investor could also use futures (the prefered method with the institutional crowd) or swaps.

The capital that is freed up by the leverage process can be used for a number of purposes. In this example, a simple additional allocation to bonds is executed. Likewise, the investor may choose to place the capital in other non-correlated asset classes. In many instances investors use the capital in a portable alpha conext (a different topic altogether and the subject of my other blog, World Alpha).