Portfolio Planning
In this section of PWM we test the performance and volatility of two investment strategies using model portfolios. Each month we look at two separate baskets of stocks related to these strategies. Global Portfolio In the June issue of PWM a global asset allocation model was presented on the basis of an optimised risk and reward relationship. Where do hedge funds fit within an all-embracing asset allocation over a medium and long-term time horizon? An optimised allocation method might provide the answer. We start with a medium-term approach which indicates the best allocation for the next three to six months based on high returns and low volatility, which is the objective of most investors, as shown in Table 1. The long-term approach with a time horizon of 12 to 24 months yields the allocation shown in Table 2. Hedge funds can be an important part of every asset allocation on the basis of a risk reward relationship over different time frames using historical data from three to 60 months. The two allocations call for weightings of 8.28 per cent and 11.49 per cent respectively. A diversification of 10 per cent into hedge funds might therefore be a reasonable assumption to make. Which funds might be best suited for our global portfolio? The 10 funds in Table 3 made it into the top list on the basis of at least five years’ price. The funds are listed by the allocation weight, which means that the best fund in terms of risk and return are at the top of the list. According to Table 3, the portfolio has done extremely well. However, we can see from Figure 4 that it has a defensive character, which means that it could return less than the hedge fund index in boom times as seen in 1999–00 or the beginning of 1998.
Optimised Alternative portfolio It might sound crazy to use an optimisation model in order to create a fund of alternative funds. There is no doubt that much more work needs to be done for a successful product, but an excellent optimisation is a good start. The optimisation process is twofold as the alternative categories are allocated first followed by the funds of each category. Arbitrage hedge funds show the highest weighting (26.721 per cent) followed by money market global (24.496 per cent). The second optimisation step involves the single funds, which are included at a proportional weight. The top three funds of each category and only funds with at least five years of history are included. The blue line of Chart 2 on this page shows the performance of a fund of 13 alternative funds that show a consistent performance. The red line is the hedge fund index, which shows flat performance over the last three years. The pink line is the optimised portfolio of the alternative fund categories. The right tool and a good optimisation process might help to avoid such a flat performance. For further information on Brainpower’s professional portfolio analysis software, please visit www.brainpowerweb.com
or contact Alan Parmenter on +44 (0) 20 7392 7108. Data, charts and comment supplied by Brainpower
