Fine-grained asset allocation

Financial Planning - Financial planning in general. (Moderated) 

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Subject Author Date Fine-grained asset allocation Simon Templar 03-09-2007  Re: Fine-grained asset allocation jIM 03-10-2007  Re: Fine-grained asset allocation beliavsky 03-11-2007
Posted by Simon Templar on March 9, 2007, 7:14 pm X-No-Archive: yes Hello, I have a question about fine-grained asset allocation. Here's the situation. For better or worse, I subscribe to the efficient market theory. I know it's not a panacea, but having a balanced portfolio invested in index funds and ETF's has worked well for me. Now, I tend to asset allocate at a higher level. e.g 1. A% in Domestic Equity = x% in US Large Cap + y% in US Small Cap, 2. B% in International Equity = j% in International Developed + k% in International Emerging, etc. You get the picture. For each of these categories, I tend to have concentrated holdings in a core index or mutual fund that is representative of that asset class. However, I do not take the asset allocation down to a further level of detail, to slice and dice all the various sectors.If I was doing it, the above breakdown might look like this. 1. A% in Domestic Equity = a% in US Financials + b% in US Healthcare + c% in US Energy + d%... 2. B% in International Equity = g% in W Europe + h% in E Europe + i% in Middle East + j%... So my question is: is such a fine-grained level of asset allocation worth it? Does it really buy you anything in terms of risk-adjusted returns? What's the differential between the coarse-grained and fine-grained models? Thanks for your comments. Simon Posted by jIM on March 10, 2007, 8:39 am > X-No-Archive: yes > > Hello, > > I have a question about fine-grained asset allocation. Here's the situation. > For better or worse, I subscribe to the efficient market theory. > I know it's not a panacea, but having a balanced portfolio invested > in index funds and ETF's has worked well for me. > > Now, I tend to asset allocate at a higher level. e.g > 1. A% in Domestic Equity = x% in US Large Cap + y% in US Small Cap, > 2. B% in International Equity = j% in International Developed + k% in International Emerging, > > etc. You get the picture. > > For each of these categories, I tend to have concentrated holdings in a core index or mutual fund that is > representative of that asset class. > > However, I do not take the asset allocation down to a further level of detail, to slice and dice all the > various sectors.If I was doing it, the above breakdown might look like this. > > 1. A% in Domestic Equity = a% in US Financials + b% in US Healthcare + c% in US Energy + d%... > 2. B% in International Equity = g% in W Europe + h% in E Europe + i% in Middle East + j%... > > So my question is: is such a fine-grained level of asset allocation worth it? Does it really buy you > anything in terms of risk-adjusted returns? What's the differential between the coarse-grained and > fine-grained models? > > Thanks for your comments. > > Simon A portfolio x ray would tell you what the finer grained holding are. It has value- if you find that your domestic LC and SC plus your internations LC and SC all invest in tech, you might be 30% tech, and that might be too much risk for you (even though you THOUGHT you were more diversified. Posted by on March 11, 2007, 3:33 pm <snip> > Now, I tend to asset allocate at a higher level. e.g > 1. A% in Domestic Equity = x% in US Large Cap + y% in US Small Cap, > 2. B% in International Equity = j% in International Developed + k% in International Emerging, > > etc. You get the picture. > > For each of these categories, I tend to have concentrated holdings in a core index or mutual fund that is > representative of that asset class. > > However, I do not take the asset allocation down to a further level of detail, to slice and dice all the > various sectors.If I was doing it, the above breakdown might look like this. > > 1. A% in Domestic Equity = a% in US Financials + b% in US Healthcare + c% in US Energy + d%... > 2. B% in International Equity = g% in W Europe + h% in E Europe + i% in Middle East + j%... > > So my question is: is such a fine-grained level of asset allocation worth it? Does it really buy you > anything in terms of risk-adjusted returns? What's the differential between the coarse-grained and > fine-grained models? <snip> You did not say how you determined weights in large vs. small caps or foreign developed vs. emerging markets -- one approach is to use weights that produced good risk-adjusted returns over a long historical period. I'd be wary of fixing weights by industry, because the importance of various industries in the economy and especially in the stock market will vary over time. For example, I'd guess that U.S. automakers and auto parts suppliers were once a much bigger part of the U.S. stock market than they are now, but since their share of corporate profits has fallen (to put it mildly), and their relative market cap has fallen accordingly, an investor probably SHOULD have a lower weight in them. On the flip side, health care is a bigger part of the economy and stock market than it was 50 years ago and should have a higher weight. If one wants to allocate by industry and allow for varying weights, one could estimate covariances and expected returns and find the "optimal" portfolio. As has been discussed here before, whether one can estimate these quantities accurately enough to create portfolios that do better than cap-weighted indices is debatable. Recently there has been research on "fundamental indexing" (FI) of stocks using weights based on earnings, dividends, revenues, and other measures, instead of market capitalization. ETFs using FI exist, for example from WisdomTree. An investor could apply FI himself at the sector level using (for example) the sector IShares for the S&P 500. Similar Threads Posted Asset Allocation and MVO May 16, 2007, 7:12 pm Pls help Asset Allocation Question October 13, 2006, 6:49 pm Asset Allocation question October 20, 2006, 6:24 pm Asset Allocation question December 22, 2006, 11:25 am re: asset allocation/ bonds January 9, 2007, 1:34 pm Re: Matrix Asset Allocation August 1, 2007, 4:05 pm Zvi Bodie's asset allocation January 27, 2008, 7:27 pm Re: Zvi Bodie's asset allocation January 31, 2008, 12:20 pm Does a person have only one asset allocation? March 31, 2008, 8:12 am Help for asset allocation theory April 14, 2008, 1:25 pm