|Founder and President|
Investment Protection Service
|Founded in 1993, Investment Protection Service is an independent money manager for institutional clients and high-net-worth individuals.|
|Investment Protection Service|
|Adjustments for risk|
Morningstar® EnCorr® is powerful. I use it for tasks including tactical asset allocation and testing assumptions in the real world. Our model portfolios are designed to remain within a target standard deviation range. I use EnCorr to evaluate the standard deviation of 10 or 15 asset classes in aggregate. When my correlations change, I can decompose that mix and determine what adjustments need to be made to bring it back to its target risk.
An early warning
The target standard deviation of my conservative model is
3-5%; in August and September of 2008, my regression analysis showed correlations increasing, and my aggregate standard deviations were exploding to the upside.
|This forced me to re-optimize to get the standard deviation back to my target risk, and resulted in an 80% allocation in short-term T-bills—right where you wanted to be when the market went off the cliff. EnCorr allowed me to be tactical in our asset allocation, in a quantified way. We were down 11.5% in 2008. [The Standard & Poor’s 500 index ended 2008 down 38.5%.] So far in 2009, we’ve been able to outperform the market, preserving our capital. |
Allocations with added stability
The real beauty of EnCorr is the windows-based MVO (mean-variance optimizer). While MVO is not an “answer,” it is a foundational tool for determining an optimal asset allocation.
|The constraints you can apply in EnCorr’s optimizer allow you to hedge, balance, and decide where you want the volatility of your portfolios to be. If I constrain a particular asset class to 5% of the portfolio, EnCorr can tell me where to look for over-weighting. It would take half a day to figure that out with a calculator. Resampling is an added bonus that gives your asset allocations a bit more stability. |