Many in the Asset Management world know that incorporating views in portfolio allocation is often an arbitrary process that does not lend itself well to objective evaluation. A classic example of this is the conversion of Strategic Asset Allocation (SAA) guidelines into implementable Tactical Asset Allocation (TAA) portfolios.
For those who tend to rarely change their allocation profile, the resulting picture is a static, or pseudo-static, allocation that looks like this.
Chart 1 -- Historical Allocation – Static Portfolio
When the allocation methodology is dynamic, the allocation picture typically looks like the picture below, with portfolio weights changing over time based on the output of the chosen allocation methodology. Dynamic allocation engines are many and include methodologies such as risk parity, minimum variance and mean-variance optimisation (MVO), all of which are supported on the ALPIMA platform, along with many more.
Chart 2 - Historical Allocation – Dynamic Portfolio
With the ALPIMA platform, it is possible to systematically take into account market views into a given portfolio.
We do this using a Black-Litterman approach where the “prior”, i.e. the starting portfolio, can be either a static or a dynamic allocation. The key inputs are market views with their respective probabilities. The “post”, i.e. the resulting portfolio, is a view-adjusted version of the starting portfolio. When the “prior” is static, the resulting allocation looks like this, with the blue bars indicating moments in time when views have been applied.
Chart 3 -- Historical Allocation – View-Adjusted Portfolio
The ability to systematically incorporate views into portfolio allocation offers several benefits:
- First, it takes away the arbitrary nature of the process, thereby increasing transparency and saving considerable time.
- Second, it allows to objectively assess the impact of human views on allocation, and ultimately, on performance, which helps to improve accountability.
- Third, it allows portfolio allocation to adapt to market changes over and above what a pure systematic approach would do. This may result in greater responsiveness to rapid regime changes, which low frequency risk-based engines often tend to detect too late.
Interestingly, the process can also be reversed to create a portfolio to view (PTV) analysis. If the adoption of market views shape portfolio allocation in a certain way, conversely, a given portfolio allocation implies certain market views vs a given framework, which can help evaluate if the current portfolio allocation is in line with market convictions.
Contact us if you would like to know more about the fusion of systematic portfolio construction and market views.