Portfolio allocations

If you want to be sure something is left when you die, here s a plan that will work for you. Harvard University s endowment fund developed a spending guideline in 1973 to ensure a person wouldn t prematurely run out of money. The rule assumes a balanced portfolio allocated half to stocks and half to bonds and cash equivalents. It limits the first-year withdrawal to four percent of the portfolio s total value. Then, in each following year, increase this amount by the previous year s rate of inflation. Continue in this manner from year to year. For example, if you have a 500,000 portfolio, you could withdraw 20,000 in the first year. If the rate of inflation were 3.5 percent that year, you could withdraw 20,700 the second year. 

Since scope economies are especially hard to quantify, a separate class of optimization models solely dealing with plant loading decisions can be found. For example, Mazzola and Schantz (1997) propose a non-linear mixed integer program that combines a fixed cost charge for each plant-product allocation, a fixed capacity consumption to reflect plant setup and a non-linear capacity-consumption function of the total product portfolio allocated to the plant. To develop the capacity consumption function the authors build product families with similar processing requirements and consider effects from intra- and inter-product family interactions. Based on a linear relaxation the authors explore both tabu-search heuristics and branch-and-bound algorithms to obtain solutions. 

Hedge Fund Return Total Portfolio Allocation ... 

In an unadulterated world, MV analysis would simply be applied to after-tax return, risk, and correlations to produce tax-efficient portfolios. Regrettably, tax law is complex and there are a variety of alternative tax structures for holding financial assets. In addition, there are tax-free versions of some instruments such as municipal bonds. Further complicating the analysis is the fact that one must know the split between ordinary income and long-term gains to forecast MV model inputs. This muddles what would otherwise be a fairly straightforward portfolio-allocation problem and requires that tax structure subtleties be built into the MV framework to perform tax-efficient portfolio optimization. 

When it comes to applying the MV approach to taxable investing, the methodology is the same as that used for tax-free portfolios, except that four different after-tax return streams, risk measures, and four-square correlations are required for each asset. Table 6 compares the pre-tax and after-tax returns for assets typically considered in taxable portfolio allocation studies. 

The business cycle is perhaps the single most important factor driving sector spread performance. Some sectors such as autos and capital goods are more influenced by business cycles than others such as tobacco and utilities. Therefore, the position in, and direction of, the business cycle will be an important input in portfolio allocation by industry sector. 

Portfolio allocations by credit quality need to be taken in conjunction with that by industry sector. This is due to the concentration of names in the industry in a particular rating tier for example, in Europe most major telecom operators are now in the single-A category, while banks constitute a large chunk of double-A rated bonds. It would therefore be virtually impossible to construct a portfolio that is overweight Banks and simultaneously underweight double-A credit. 

One characteristic generally associated with bond buyers is that they are older, more conservative, and more sophisticated with respect to investing than the rest of the investing public. This is especially true regarding municipal bond investors, who are often retirees who may have as much as 90 percent of their portfolios allocated to these securities in order to take advantage of the tax strategies. These savvy investors also prefer access to substantial information before making a purchase. 

Allen Clamen Tell me a little bit more about to what you re referring. The work that I have described was individual businesses looking at their portfolios from a business standpoint in order to ascertain how all the resources internally are being allocated. I m not talking about, in this case, supporting a central corporate laboratory. That may be behind some of this. 

Michael Schrage Absolutely, but in both of those contexts the convergence of allocation of overhead is present. Given a portfolio and a particular perception, we want to charge a certain amount to overhead rather than another amount. If the portfolio is put in the incremental innovation category, we do a different overhead formulation than if it is pioneering research. 

David J. Soderberg, BP Chemicals You mentioned a very coherent and concise set of tools that are used portfolio management, fuzzy front end, and stage gate. Those work very well within a business unit context. They re very focused and allow you to allocate resources. 

Without any changes to the production network, the operating cash flows and the NPV of the network would be reduced by approximately 10% in comparison to the baseline values. However, by re-allocating production volumes within existing capacities, it is possible to restore previously earned operating cash flows. To do so, production volumes are shifted to the major site A, which is located in the Euro zone. Contrarily, site C, which is located in the USA, would not be utilized at all by the product groups included in the example. It should be noted that this does not imply a closure of the US site since only a subset of the product portfolio was included in the analysis. The net present value of the network is nevertheless affected by the US appreciation because of the restructuring costs associated with the re-allocation of production volumes. 

As discussed previously, if you cannot tolerate your investment portfolio declining by 30% percent in one year, you do not want to have an all-stock portfolio (because the largest historical one year decline was 43.3%). But how should you allocate your resources Suppose that you can tolerate a 20% decline or a 10% decline Based on historical returns and using large stocks and long-term bonds as major asset classes to design a portfolio, you should not have more than 40% stocks in your portfolio ifyou cannot tolerate agreater than 20%... 

The plan for the coming year requires that work be done on four separate projects. The total budget that has been agreed with the Business Manager allows for nine people to be allocated across the portfolio of projects. The agreed allocation of the nine people to each project is as shown in Table A3. 

The design of the project portfolio (and also the allocation of resources) is based on the objectives that are determined by the management team. We have found it useful to rank each project - typical major ones include projects to develop the vision, to realize the full potential to add value, and to insure the effective operation of the new businesses, in line with the three key aspects described... 

Studies have consistently shown that selection of the asset mix is the most important determinant of investment performance. Early influential research by Brinson et al. (1986, 1991) and a more recent update by Ibbotson and plan (1999) indicate that asset allocation explains up to 90% of portfolio returns. Security selection and other factors explain the remainder. Consequently, the asset blend is the key intellectual challenge for investment managers and should receive the most attention. Traditional rules of thumb no longer work in a dynamic world with many choices and unexpected risks. 

Markowitz was the first to propose an explicit quemtification of the asset-allocation problem (Markowitz 1959). Three categorical inputs are required the expected return for each asset in the portfolio, the risk or variance of each asset s return, and the correlation between asset returns. The objective is to select the optimal weights for each asset that meiximizes total portfolio return for a given level of portfoho risk. The set of optimum portfohos over the risk spectrum traces out what is called the efficient frontier. 

With respect to computation, for limited numbers of assets (small /), solutions are easily obtained (although not necessarily efficiently) using standard spreadsheet optimizers. This works for the vast majority of allocation problems because most applications typically include no more than a dozen assets. More specialized optimizers are sometimes necessary when there are many assets. For example, if MV is applied to select a stock portfolio, there may be hundreds of securities used as admissible assets. ... 

As an example of the extrapolation faUacy, consider portfolio performance over the last two decades. If one constructed an efficient portfoUo in 1990 bas on the 1980s history, laige allocations would have been made to international equities. This is primarily due to the fact that lapanese stocks produced the best returns in the woild up to 1989. Yet in the 1990s, Japanese equities feU by more than 50% from their 1989 peak, and the best asset allocation would have been to U.S. equities. Using the 1980s history to construct MV portfoUos would have produced dismal portfoUo returns (Table 3). 

For example, consider a simple portfolio of U.S. equities and bonds. Normally managers with the best forecasts wiU achieve better performance than other managers investing in the same assets. But another manager, who may not forecast U.S. equity and bond returns extremely well, can outperform by allocating funds to assets such as international equities and bonds. These assets possess different returns, risks, and correlations with each other and U.S. assets. Their inclusion shifts the efficient frontier upward beyond that resulting when only U.S. stocks and bonds are considered. 

The discussion so far has focused on asset allocation as generally applicable to a broad cross-section of investors. In reality, the vast majority of individual investors face special restrictions that limit their flexibility to implement optimal portfolios. For example, many investors hold real estate, concentrated stock holdings, VC or LBO partnerships, restricted stock, or incentive stock options that for various reasons cannot be sold. For these investors, standard MV optimization is stiU appropriate and they are weU advised to target the prescribed optimum portfolio. They should then utilize derivative products such as swaps to achieve a synthetic replication. 

---