Asset Allocation

Key Takeaways

Chapter 1: What Is an Asset Class?

• The composition of an asset class should be stable.
• The components of an asset class should be directly investable.
• The components of an asset class should be similar to each other.
• An asset class should be dissimilar from other asset classes in the port- folio as well as combinations of other asset classes.
• The addition of an asset class to a portfolio should raise its expected utility.
• An asset class should not require selection skill to identify managers within the asset class.
• An asset class should have the capacity to absorb a meaningful fraction of a portfolio cost-effectively.

Chapter 2: Fundamentals of Asset Allocation

• A portfolio's expected return is the weighted average of the expected returns of the asset classes within it.
• Expected return is measured as the arithmetic average, not the geometric average.
• A portfolio's risk is measured as the variance of returns or its square root, the standard deviation.
• Portfolio risk must account for how asset classes co-vary with one another.
• Portfolio risk is less than the weighted average of the variances or stan- dard deviations of the asset classes within it.
• Diversification cannot eliminate portfolio variance entirely. It can only reduce it to the average covariance of the asset classes within it.
• The efficient frontier comprises portfolios that offer the highest expected return for a given level of risk.
• The optimal portfolio balances an investor's goal to increase wealth ...