By Bob Litterman, Quantitative Resources Group
Introduces the trendy funding administration strategies utilized by Goldman Sachs asset administration to a wide diversity of institutional and complicated traders. besides Fischer Black, Bob Litterman created the Black-Litterman asset allocation version, essentially the most generally revered and used asset allocation versions deployed through institutional traders. Litterman and his asset administration staff are usually a motive force at the back of the asset allocation and funding decision-making of the worlds biggest a hundred pension cash.
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Extra info for Modern investment management: an equilibrium approach
066. Because domestic equity risk is the only risk in the portfolio, a marginal investment in commodities, which is negatively correlated with domestic equity, reduces risk. This negative marginal contribution to portfolio risk for commodities leads to a new phenomenon. Commodities are a diversifier in the portfolio. The previous type of analysis, where we sold domestic equity and bought enough international equity to hold risk constant, doesn’t work. If we sell domestic equities and try to adjust the commodity weight to keep risk constant, we have to sell commodities as well.
Active managers do not get paid fees for creating passive exposures to broad asset classes. To pay an active fee for benchmark returns would be like paying an expensive artist to paint the walls of a room a solid color—it could be done, but it would be a waste of money. Active managers earn their fees for taking risk relative to a benchmark, referred to as active risk. Active managers deviate from benchmarks in an attempt to outperform their benchmark. These deviations are the artistry that the active managers use to create the opportunity to outperform the benchmark, but they also create the risk that the manager may underperform.
Now suppose ed / ef is less than ∆d / ∆f . How much international equity must we purchase in order to keep risk constant if we sell a small amount of domestic equities? The rate of change in risk from the sale of domestic equity sales is –∆d per unit sold. In order to bring risk back up to its previous level, we need to purchase (∆d / ∆f) units of international equity. The effect on expected return to the portfolio is –ed per unit sold of domestic equity and +(∆d / ∆f)ef from the purchase of an amount of international equity that leaves risk unchanged.