Strategic Allocation

Is there a best way to select and weight asset classes for long-term diversification benefits? These blog entries address this strategic allocation question.

Federal Reserve Holdings and the U.S. Stock Market June 4, 2013

Using quarterly data in their April 2013 preliminary paper entitled “Analyzing Federal Reserve Asset Purchases: From Whom Does the Fed Buy?” Seth Carpenter, Selva Demiralp, Jane Ihrig and Elizabeth Klee find that some categories of investors appear to sell U.S. Treasuries to the Federal Reserve and rebalance toward riskier assets (corporate bonds, commercial paper, and municipal debt). Are stocks a part of this process? To investigate, we relate weekly, monthly and quarterly U.S. stock market returns (proxied by the S&P 500 Index returns) to comparable changes in the Federal Reserve’s System Open Market Account (SOMA) holdings, comprised of U.S. Treasury bills, U.S. Treasury notes and bonds, U.S. Treasury Inflation-Protected Securities (TIP) and Mortgage-Backed Securities (MBS). The Federal Reserve reports these holdings with a small lag. Using weekly data (Wednesday closes) for the S&P 500 Index total SOMA holdings during July 2003 through May 2013, we find that: More…

Simple Tests of PSP as Diversifier May 29, 2013

Does adding a proxy for private equity to a diversified portfolio improve its performance? To check, we add PowerShares Global Listed Private Equity (PSP) to the following mix of asset class proxies (the same used in “Simple Asset Class ETF Momentum Strategy”):

PowerShares DB Commodity Index Tracking (DBC)
iShares MSCI Emerging Markets Index (EEM)
iShares MSCI EAFE Index (EFA)
SPDR Gold Shares (GLD)
iShares Russell 1000 Index (IWB)
iShares Russell 2000 Index (IWM)
SPDR Dow Jones REIT (RWR)
iShares Barclays 20+ Year Treasury Bond (TLT)
3-month Treasury bills (Cash)

First, per the findings of “Asset Class Diversification Effectiveness Factors”, we measure the average monthly return for PSP and the average pairwise correlation of PSP monthly returns with the monthly returns of the above assets. Then, we compare cumulative returns and basic monthly return statistics for equally weighted (EW), monthly rebalanced portfolios with and without PSP. We ignore rebalancing frictions, which would be about the same for the alternative portfolios. Using adjusted monthly returns for PSP and the above nine asset class proxies from November 2006 (first return available for PSP) through April 2013 (78 monthly returns), we find that: More…

Simple Tests of RWX as Diversifier May 29, 2013

A subscriber suggested testing the diversification power of SPDR Barclays International Real Estate (RWX) as a distinct asset class. To check, we add RWX to the following mix of asset class proxies (the same used in “Simple Asset Class ETF Momentum Strategy”):

First, per the findings of “Asset Class Diversification Effectiveness Factors”, we measure the average monthly return for RWX and the average pairwise correlation of RWX monthly returns with the monthly returns of the above assets. Then, we compare cumulative returns and basic monthly return statistics for equally weighted (EW), monthly rebalanced portfolios with and without RWX. We ignore rebalancing frictions, which would be about the same for the alternative portfolios. Using adjusted monthly returns for RWX and the above nine asset class proxies from April 2007 (first return available for RWX) through April 2013 (73 monthly returns), we find that: More…

Simple Tests of DBV as Diversifier May 29, 2013

Does adding a proxy for the currency carry trade among developed economies (long futures on three currencies with the highest interest rates and short futures on three currencies with the lowest interest rates) to a diversified portfolio improve its performance? To check, we add PowerShares DB G10 Currency Harvest (DBV) to the following mix of asset class proxies (the same used in “Simple Asset Class ETF Momentum Strategy”):

First, per the findings of “Asset Class Diversification Effectiveness Factors”, we measure the average monthly return for DBV and the average pairwise correlation of DBV monthly returns with the monthly returns of the above assets. Then, we compare cumulative returns and basic monthly return statistics for equally weighted (EW), monthly rebalanced portfolios with and without DBV. We ignore rebalancing frictions, which would be about the same for the alternative portfolios. Using adjusted monthly returns for DBV and the above nine asset class proxies from September 2006 (first return available for DBV) through April 2013 (79 monthly returns), we find that: More…

Simple Tests of BWX as Diversifier May 28, 2013

A subscriber suggested testing the diversification power of SPDR Barclays International Treasury Bonds (BWX) as a distinct asset class. To check, we add BWX to the following mix of asset class proxies (the same used in “Simple Asset Class ETF Momentum Strategy”):

First, per the findings of “Asset Class Diversification Effectiveness Factors”, we measure the average monthly return for BWX and the average pairwise correlation of BWX monthly returns with the monthly returns of the above assets. Then, we compare cumulative returns and basic monthly return statistics for equally weighted (EW), monthly rebalanced portfolios with and without BWX. We ignore rebalancing frictions, which would be about the same for the alternative portfolios. Using adjusted monthly returns for BWX and the above nine asset class proxies from November 2007 (first return available for BWX) through April 2013 (66 monthly returns), we find that: More…

Simple Tests of HYG as Diversifier May 28, 2013

It is plausible that high-yield corporate bonds have return characteristics substantially different from those of other asset classes, and therefore represent a good diversification opprotunity. To check, we add iShares iBoxx $ High-Yield Corporate Bond (HYG) to the following mix of asset class proxies (the same used in “Simple Asset Class ETF Momentum Strategy”):

First, per the findings of “Asset Class Diversification Effectiveness Factors”, we measure the average monthly return for HYG and the average pairwise correlation of HYG monthly returns with the monthly returns of the above assets. Then, we compare cumulative returns and basic monthly return statistics for equally weighted (EW), monthly rebalanced portfolios with and without HYG. We ignore rebalancing frictions, which would be about the same for the alternative portfolios. Using adjusted monthly returns for HYG and the above nine asset class proxies from May 2007 (first return available for HYG) through April 2013 (72 monthly returns), we find that: More…

Simple Tests of TIP as Diversifier May 28, 2013

Treasury Inflation-Protected Securities (TIPS), offering an explicit inflation hedge, may be an attractive asset for strategic diversification. To check, we add iShares Barclays TIPS Bond Fund (TIP) to the following mix of asset class proxies (the same used in “Simple Asset Class ETF Momentum Strategy”):

First, per the findings of “Asset Class Diversification Effectiveness Factors”, we measure the average monthly return for TIP and the average pairwise correlation of TIP monthly returns with the monthly returns of the above assets. Then, we compare cumulative returns and basic monthly return statistics for equally weighted (EW), monthly rebalanced portfolios with and without TIP. We ignore rebalancing frictions, which would be about the same for the alternative portfolios. Using adjusted monthly returns for TIP and the above nine asset class proxies as available from January 2004 (first available for TIP) through April 2013 (112 monthly returns), we find that: More…

Simple Tests of IEF as Diversifier May 28, 2013

It is plausible that crude oil as a dominant energy commodity has return characteristics substantially different from those of other commodities and asset classes, and therefore represent a good diversification opprotunity. To check, we add iShares Barclays 7-10 Year Treasury (IEF) to the following mix of asset class proxies (the same used in “Simple Asset Class ETF Momentum Strategy”):

First, per the findings of “Asset Class Diversification Effectiveness Factors”, we measure the average monthly return for IEF and the average pairwise correlation of IEF monthly returns with the monthly returns of the above assets. Then, we compare cumulative returns and basic monthly return statistics for equally weighted (EW), monthly rebalanced portfolios with and without IEF. We ignore rebalancing frictions, which would be about the same for the alternative portfolios. Using adjusted monthly returns for IEF and the above nine asset class proxies as available from January 2003 (the start of the “Simple Asset Class ETF Strategy”) through April 2013 (124 monthly returns), we find that: More…

Simple Tests of AMJ as Diversifier May 24, 2013

A subscriber suggested testing the diversification power of exchange-traded aggregations of U.S. pipeline Master Limited Partnerships, such as JPMorgan Alerian MLP Index ETN (AMJ), as a distinct asset class. To check, we add AMJ to the following mix of asset class proxies (the same used in “Simple Asset Class ETF Momentum Strategy”):

First, per the findings of “Asset Class Diversification Effectiveness Factors”, we measure the average monthly return for AMJ and the average pairwise correlation of AMJ monthly returns with the monthly returns of the above assets. Then, we compare cumulative returns and basic monthly return statistics for equally weighted (EW), monthly rebalanced portfolios with and without AMJ. We ignore rebalancing frictions, which would be about the same for the alternative portfolios. Using adjusted monthly returns for AMJ and the above nine asset class proxies from July 2009 (first return available for AMJ) through April 2013 (only 46 monthly returns), we find that: More…

Simple Tests of USO as Diversifier May 24, 2013

It is plausible that crude oil as a dominant energy commodity has return characteristics substantially different from those of other commodities and asset classes, and therefore represents a good diversification opportunity. To check, we add the United States Oil Fund (USO) to the following mix of asset class proxies (the same used in “Simple Asset Class ETF Momentum Strategy”):

First, per the findings of “Asset Class Diversification Effectiveness Factors”, we measure the average monthly return for USO and the average pairwise correlation of USO monthly returns with the monthly returns of the above assets. Then, we compare cumulative returns and basic monthly return statistics for equally weighted (EW), monthly rebalanced portfolios with and without USO. We ignore rebalancing frictions, which would be about the same for the alternative portfolios. Using adjusted monthly returns for USO and the above nine asset class proxies as available from May 2006 (first return available for USO) through April 2013 (84 monthly returns), we find that: More…