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
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In the remainder of this study we conduct an empirical and literature analysis to establish long-run capital market expectations for each asset class, which we subsequently use in a mean-variance analysis. Then, we provide an assessment of the global market portfolio. Finally, we show how the mean-variance and market portfolio approaches can be combined to determine optimal portfolios.

1
Electronic copy available at: http://ssrn.com/abstract=1368689

2 Methodology and data
Methodology Markowitz (1952, 1956) pioneered the development of a quantitative method that takes the diversification benefits of portfolio allocation into account. Modern portfolio theory is the result of his work on portfolio optimization. Ideally, in a mean-variance optimization model, the complete investment opportunity set, i.e. all assets, should be considered simultaneously. However, in practice, most investors distinguish between different asset classes within their portfolio-allocation frameworks. This two-stage model is generally applied by institutional investors, resulting in a top-down allocation strategy.

In the first part of our analysis, we view the process of asset allocation as a four-step exercise like Bodie, Kane and Marcus (2005). It consists of choosing the asset classes under consideration, moving forward to establishing capital market expectations, followed by deriving

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