The New Science of Asset Allocation: Risk Management in a Multi-Asset World

CHAPTER 4

Asset Classes: What They Are and Where to Put Them

This chapter provides the building blocks for multi -asset allocation. We do not attempt to change accepted approaches to asset class determination as much as to expand it to include a wider set of potential investments including a range of alternative investments (e.g., private equity, commodities, real estate, hedge funds, CTAs). For many, the question still exists: do alternative investments provide the average investor with valuable return and risk opportunities beyond that available in traditional stock and bond investments? In its most simple form, the total risk of an equal weighted stock (high volatility) and bond (low volatility) portfolio is not split equally between the stock and bond investment but is in fact impacted primarily by the high risk stock investment. The potential addition of a range of other investment classes should at least offer one answer to this stock/bond conundrum. The answer to the benefits of asset allocation in a multi-asset universe may simply be that “more is better than less.” Additional assets may provide investors with greater access to return opportunities that may not exist in other states of the traditional stock and bond world.

In addition, the crux of asset allocation is reliable and independently verifiable information. The creation of asset classes for which the fundamental return process cannot be monitored or managed is of little use. Black boxes, whether in the form ...