Capital market expectations, strategic asset allocation, investment policy statements, liability-driven and behavioral considerations.
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- What is the primary purpose of capital market expectations in strategic asset allocation?
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To provide forecasts of expected returns, volatility, and correlations of asset classes that inform allocation decisions.- Define the equity risk premium in capital market expectations.
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The expected excess return of equities over risk-free securities, compensating investors for bearing market risk.- What is the key difference between expected return and required return?
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Expected return is what markets forecast; required return is the minimum needed to meet investor goals and obligations.- What does an investment policy statement (IPS) establish?
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A written document specifying the investor's goals, constraints, risk tolerance, and the investment manager's mandate.- Name three main components of a comprehensive IPS.
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Investor background and objectives, constraints, and asset allocation policy with rebalancing guidelines.- What does liability-driven investment (LDI) seek to accomplish?
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Match assets with future liabilities in terms of duration, timing, and magnitude of cash flows to minimize funding risk.- How does duration matching reduce portfolio risk in LDI?
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It aligns the duration of assets with liabilities so that interest rate changes affect both similarly, protecting funded status.- What is a liability benchmark in portfolio management?
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A return target or performance index reflecting the minimum return required to meet future investor obligations.- Describe home bias in asset allocation.
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The tendency of investors to overweight domestic assets beyond their proportional share in a global market portfolio.- What is loss aversion bias and how does it affect asset allocation?
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The tendency to feel loss pain more acutely than gain pleasure, leading investors to allocate more conservatively than their objectives warrant.- What does mean-variance optimization determine?
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The efficient frontier of asset allocations that maximizes return for a given risk level or minimizes risk for a target return.- Define rebalancing in the context of portfolio management.
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Periodically adjusting the portfolio by buying and selling assets to restore allocations to their target percentages.- What characterizes calendar-based rebalancing?
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Rebalancing occurs at fixed time intervals such as quarterly or annually, regardless of how allocations have drifted.- How does threshold-based rebalancing work?
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Rebalancing occurs only when an asset class deviates from its target allocation by a predetermined percentage, such as 5 percent.- Why might an investor combine calendar and threshold rebalancing strategies?
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Calendar rebalancing ensures discipline and periodic review, while threshold rebalancing minimizes unnecessary trading when drift is minor.
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