Portfolio Design: A Modern Approach to Asset Allocation

HIGH NET WORTH (HNW) PORTFOLIOS

Several portfolios with alternative investments are examined. The first two portfolios are designed for high net worth investors who are willing to invest in hedge funds and commodity futures as well as in real estate, stocks, and bonds. Both HNW portfolios have 25 percent invested in bonds, 50 percent in stocks, and 25 percent in alternative investments (including real estate). The first of these portfolios has 10 percent in hedge funds, 5 percent in commodity futures, and 10 percent in REITS. This portfolio is illustrated on the right side of Figure 13.3. The second HNW portfolio excludes commodity futures with the REIT allocation increased to 15 percent from 10 percent. The other portfolios are designed for ultra-high net worth investors who can cope with the illiquidity of venture capital and private equity investments. These portfolios will be discussed below.

The two HNW portfolios are examined in Table 13.3. The hedge fund index used for these portfolios is the HFRI Fund of Funds index since high net worth investors usually cannot diversify manager risk adequately by investing directly in hedge funds.7 The expected returns of each portfolio are calculated using Zephyr AllocationADVISOR, but only after the individual asset returns are replaced by the estimated returns obtained using the premium method (as in Table 13.2).8 The standard deviations and correlations for each portfolio are measured by Zephyr from February 1991 (when the DJ UBS index ...