Asset Allocation

[derswap07]

Hi All,
EOC Q 1 B - all subparts. I fail to understand waht is asked and the answer given.
Clarification please.
Thanks.

 

[cpk123]

this relates completely to section 2.3 in the book. read it …

 

[derswap07]

I read it- it still does not make sense to me.

 

[cpk123]

When they talk of time series sense in each of these below - they are talking of comparing the asset allocation across multiple periods in time.
Time series sense - same portfolio across multiple periods in time.
cross sectional sense - portfolio of different investors….

Quote:
“i. rebalancing to the policy mix.”

when you rebalance to the policy mix - every so often - in the end of n periods - your asset allocation will look more like the original strategic asset allocation. So now if you did a regression of your original strategic asset allocation against every other period after you rebalanced - your correlation across periods will be closer to 1. So the answer -> ” the more important strategic asset allocation will appear in a time-series sense”

Quote:
“ii. investing actively within an asset class or indexing to asset.”

if they index to an asset class - that means they would rebalance to that asset class when the policy mix changes. In that case - the importance of the original strategic allocation would increase. This is pretty much doing what was done in the item i discussed above.
However if they chose to invest actively within an asset class - they might chose to e.g. use more of long term bonds within the bond asset class … this means the importance of that particular asset within the asset class increases - so the overall importance of the asset itself changes in a time series sense.
Now read the answer provided in the book and see if it makes sense.

Quote:
“iii. adopting a policy portfolio that is much different from those of peers.”

answer: “By itself, choosing a policy portfolio that is distinct from one’s peers should not affect asset allocation’s measured importance in a time-series sense. It will tend to differentiate RFM’s returns from those of its peers, however, and tend to make asset allocation appear important in a cross- sectional sense.”
what does this mean?
if you have an allocation mix, and then go back to that allocation mix consistently - in a time series sense - you are sticking to your portfolio like in item i above.
However if you compare the allocation across different investors – (cross sectional) - then your asset allocation would be more important - different from – others.
HTH