Asset Allocation: Index Funds

Topics: Modern portfolio theory, Standard deviation, Arithmetic mean Pages: 3 (452 words) Published: April 7, 2014
Q1. Calculating Inputs
We chose assets from the 1990s, which was one of the most prolific decades in market history thanks in large part to the tech bubble. We chose to calculate average returns as 12x the monthly average return. This annualizes our return, which provides a better representation of returns by including more data points to perform analysis. The arithmetic calculation provides an impartial estimate of future return because it is always more than the geometric. All assets classes reported positive returns from 1990 through 1999, while the S&P 500 index had the highest annual average return of 17.7%. The Russell 2000 had the second highest annual return with a standard deviation of 14.1% & 17.2%. Treasuries and bond returns were a poor performer relative to the other assets which were in-line with our group’s anticipations. However, the MSCI Index reported a lower return than the treasuries and bonds along with the second greatest standard deviation. Events such as, Russia’s sovereign debt default in 1998, which ultimately brought down LTCM likely increased the risk profile of the MSCI. Not surprisingly bonds and MSCI Index returned the lowest correlations when paired with other assets classes. This is primarily reflected in lower returns during decade and higher risk from emerging markets in the case of MSCI Index.

U.S. 30 Day TBill TRRussell 2000 TRS&P 500 TRLB LT TRMSCI EAFE TR Mean0.4%1.2%1.5%0.7%0.7%
Std. Dev0.1%5.0%3.9%2.1%4.9%

CorrelationRussellS&P 500LT BondEAFE
S&P 5000.7801.000
LT Bond0.1910.4131.000

Q2. Optimal Asset Allocation
a)For each portfolio return highlighted in yellow in the spreadsheet ‘Efficient Frontier’, calculate the minimum unconstrained portfolio standard deviation.
Port MeanSum of
WeightsReturnPort wgts.
Target Port MeanSt. Dev...
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