Strategic Asset Allocation: Determining the Optimal Portfolio with Ten Asset Classes

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Strategic Asset Allocation: Determining the Optimal Portfolio with Ten Asset Classes

Niels Bekkers Mars The Netherlands

Ronald Q. Doeswijk* Robeco The Netherlands

Trevin W. Lam Rabobank The Netherlands

October 2009

Abstract

This study explores which asset classes add value to a traditional portfolio of stocks, bonds and cash. Next, we determine the optimal weights of all asset classes in the optimal portfolio. This study adds to the literature by distinguishing ten different investment categories simultaneously in a mean-variance analysis as well as a market portfolio approach. We also demonstrate how to combine these two methods. Our results suggest that real estate, commodities and high yield add most value to the traditional asset mix. A study with such a broad coverage of asset classes has not been conducted before, not in the context of determining capital market expectations and performing a mean-variance analysis, neither in assessing the global market portfolio. JEL classification: G11, G12 Key words: strategic asset allocation, capital market expectations, mean-variance analysis, optimal portfolio, global market portfolio. This study has benefited from the support and practical comments provided by Jeroen Beimer, Léon Cornelissen, Lex Hoogduin, Menno Meekel, Léon Muller, Laurens Swinkels and Pim van Vliet. Special thanks go to Jeroen Blokland and Rolf Hermans for many extensive and valuable discussions. We thank Peter Hobbs for providing the detailed segmentation of the global real estate market that supplemented his research paper. Last, but not least, we thank Frank de Jong for his constructive comments and useful suggestions during this study. * Corresponding author, email: r.doeswijk@robeco.com, telephone: +31 10 2242855.

Electronic copy available at: http://ssrn.com/abstract=1368689

1 Introduction
Most previous academic studies agree on the importance of strategic asset allocation as a determinant for investment returns. In their frequently cited paper, Brinson, Hood and Beebower (1986) claim that 93.6% of performance variation can be explained by strategic asset allocation decisions. This result implies that strategic asset allocation is far more important than market timing and security selection.

Most asset allocation studies focus on the implications of adding one or two asset classes to a traditional asset mix of stocks, bonds and cash to conclude whether and to what extent an asset class should be included to the strategic portfolio, see for example Erb and Harvey (2006) and Lamm (1998). However, because of omitting asset classes this partial analysis can lead to sub-optimal portfolios. This is surprising, as pension funds and other institutions have been strategically shifting substantial parts of their investment portfolio towards non-traditional assets such as real estate, commodities, hedge funds and private equity.

The goal of this study is to explore which asset classes add value to a traditional asset mix and to determine the optimal weights of all asset classes in the optimal portfolio. This study adds to the literature by distinguishing ten different investment categories simultaneously in a mean-variance analysis as well as a market portfolio approach. We also demonstrate how to combine these two methods. Next to the traditional three asset classes stocks, government bonds and cash we include private equity, real estate, hedge funds, commodities, high yield, credits and inflation linked bonds. A study with such a broad coverage of asset classes has not been conducted before, not in the context of determining capital market expectations and performing a mean-variance analysis, neither in assessing the global market portfolio. The second step in portfolio management, i.e. market timing and security selection are tactical decisions. These are beyond the scope of this study.

In short, this study suggests that adding real estate, commodities and high yield to...
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