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2010 The α – β Spectrum β α The Whole Market An Individual Stock
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Using an alpha-discovery strategy to screen the market
2010 The α – β Spectrum “Smart Beta” β α Style β The Whole Market Value, Growth An Individual Stock Using an alpha-discovery strategy to screen the market
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Using a “standard” alpha factor similarity to screen the market
2010 The α – β Spectrum β α Style β Sector β The Whole Market Value, Growth An Individual Stock e.g., banking, healthcare Using a “standard” alpha factor similarity to screen the market
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alpha factor similarity
2010 The α – β Spectrum β α Loosely Screened β Tightly Screened β Targeted β The Whole Market Value, Growth An Individual Stock e.g., banking, healthcare e.g., brand value ranking Using a non-standard alpha factor similarity to screen the market
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The α – β Spectrum 2010 β α An Asset Class Individual Assets
Loosely Screened β Tightly Screened β Targeted β α An Asset Class Individual Assets
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Investment Grade Bonds
2010 The α – β Spectrum β α Loosely Screened β Tightly Screened β Targeted β US Equities β α Loosely Screened β Tightly Screened β Targeted β Treasurys β α Loosely Screened β Tightly Screened β Targeted β Investment Grade Bonds β α Loosely Screened β Tightly Screened β Targeted β Hi-Yield Bonds
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The α – β Spectrum 2010 U.S Japan Euro-Zone China etc. β α
Loosely Screened β Tightly Screened β Targeted β US Equities Treasurys Investment Grade Bonds Hi-Yield Bonds U.S β α Loosely Screened β Tightly Screened β Targeted β Equities Govt Bonds Investment Grade Bonds Hi-Yield Bonds β α Loosely Screened β Tightly Screened β Targeted β Equities Govt Bonds Investment Grade Bonds Hi-Yield Bonds β α Loosely Screened β Tightly Screened β Targeted β Equities Govt Bonds Investment Grade Bonds Hi-Yield Bonds β α Loosely Screened β Tightly Screened β Targeted β Equities Govt Bonds Investment Grade Bonds Hi-Yield Bonds β α Loosely Screened β Tightly Screened β Targeted β Equities Govt Bonds Investment Grade Bonds Hi-Yield Bonds Japan β α Loosely Screened β Tightly Screened β Targeted β Equities Govt Bonds Investment Grade Bonds Hi-Yield Bonds Euro-Zone China etc.
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“α” Selecting Beta 2010 U.S Japan Euro-Zone China A Selection Problem
β α Loosely Screened β Tightly Screened β Targeted β US Equities Treasurys Investment Grade Bonds Hi-Yield Bonds U.S β α Loosely Screened β Tightly Screened β Targeted β Equities Govt Bonds Investment Grade Bonds Hi-Yield Bonds β α Loosely Screened β Tightly Screened β Targeted β Equities Govt Bonds Investment Grade Bonds Hi-Yield Bonds β α Loosely Screened β Tightly Screened β Targeted β Equities Govt Bonds Investment Grade Bonds Hi-Yield Bonds β α Loosely Screened β Tightly Screened β Targeted β Equities Govt Bonds Investment Grade Bonds Hi-Yield Bonds β α Loosely Screened β Tightly Screened β Targeted β Equities Govt Bonds Investment Grade Bonds Hi-Yield Bonds Japan β Loosely Screened β Tightly Screened β Targeted β α Equities Euro-Zone β Loosely Screened β German Banking Debt Screened β Targeted β α Govt Bonds China β Loosely Screened β Tightly Screened β Targeted β α Investment Grade Bonds A Selection Problem β Loosely Screened β Tightly Screened β Targeted β α Hi-Yield Bonds So, what do you really have again?
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2010 Asset Allocation Beta Strategies
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The Asset Allocation Gameboard
2010 The Asset Allocation Gameboard Passive Maximum β More β Less β Maximum α US equities Active Bogle Lynch Indexes, ETFs Picking winners
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The Asset Allocation Gameboard
2010 The Asset Allocation Gameboard Maximum β Maximum α US equities European Equities Emerging Markets Equities
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The Asset Allocation Gameboard
2010 Two Selections The Asset Allocation Gameboard Active/Passive Strategy Choice Maximum β Maximum α Equities Govt Bonds Corporate Bonds Commodities Cash Private Equity Asset Classes
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Defining the asset classes
2010 Defining the asset classes Asset classes defined by “broad sweeping differences in fundamental character” debt vs equity domestic vs foreign inflation-sensitive vs deflation-sensitive private vs public liquid vs illiquid
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Defining the asset classes
2010 Defining the asset classes Assets in an Asset Class should all respond the same way to key economic variables, like inflation
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Weighting the asset classes
2010 Weighting the asset classes “Most portfolios work well with around half a dozen asset classes” At least 5% of the portfolio per asset class No more than about 30% per asset class
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Portfolio Construction
2010 Portfolio Construction Choice of Bias (among asset classes)
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The Asset Allocation Gameboard
Maximum β Maximum α Equities Govt Bonds Corporate Bonds Commodities Cash Private Equity 1/6 How do you spread your “bets” across the various asset classes? 1/6 1/6 1/6 Any imbalanced spread represents a “Bias” 1/6 1/6
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Swensen argues strongly for an Equity Bias
2010 Asset Class Selection Positive Bias: Equity Bias Negative Bias: Avoidance of “Bad Asset Classes" Swensen argues strongly for an Equity Bias
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Reasons for Equity Bias
2010 Reasons for Equity Bias Based on Historical Performance Market Efficiency
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The Equity Bias: Historical Performance
Asset Class Multiple Inflation 11 Treasury Bills 18 Treasury Bonds 71 Corporate Bonds 100 Large-cap Stocks 2,658 Small-cap Stocks 13,706
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Market Efficiency Best Hard Best Hard Poor Best Best Equities
Maximum β Maximum α Equities Govt Bonds Corporate Bonds Commodities Cash Private Equity Best Hard Best Hard Poor Best Best
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Misalignment of Investors’ Interests with Managers’ Interests
2010 Bias Based on Historical Performance Market Efficiency “Agency” Problems Misalignment of Investors’ Interests with Managers’ Interests
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Corporate Bonds are always Bad
Efficiency Maximum β Maximum α Equities Govt Bonds Corporate Bonds Commodities Cash Private Equity Best Hard Best Corporate Bonds are always Bad Best Best
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Portfolio Construction
2010 Portfolio Construction Choice of Bias (among asset classes) Diversification – good anti-correlation characteristics vs Equity Diversification Objective (correlations) Market Regime Assumption
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Baseline Equities Maximum β Maximum α Cash Govt Bonds Corporate Bonds
Commodities Cash Private Equity
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Inflation > 5% per year
Maximum β Maximum α Equities Govt Bonds Corporate Bonds Commodities Cash Private Equity
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How should the portfolio be repositioned?
Market Regimes Inflation Deflation Fed Unwinding Greek Default How should the portfolio be repositioned?
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