### Tests of Strategic Allocations Based on Risk Metrics

**September 18, 2012** - Strategic Allocation, Volatility Effects

Risk-focused asset allocation strategies derive from evidence that forecasting asset return volatility is easier than forecasting average return. Is there a best risk-focused strategy? In his September 2012 paper entitled “A Small Survey of Quantitative Models that Discard Estimation of Expected Returns for Portfolio Construction”, Stefano Colucci compares asset allocation strategies that rely on forecasted asset risk metrics but not on forecasted average returns. Specifically, he compares future gross annualized return-risk ratios, Ulcer indexes, one-month maximum drawdowns and average monthly portfolio turnovers for the following asset allocation strategies:

- Minimum Variance (least volatile, or left-most, efficient portfolio per Modern Portfolio Theory).
- Minimum Expected Shortfall with weightings estimated by Monte Carlo simulation.
- Equal Risk Contribution (each asset weighted by the inverse of its forecasted maximum expected shortfall).
- Maximum Diversification (related to expected shortfall with weightings again estimated by numerical simulation).
- Risk Parity (each asset weighted by the inverse of its portfolio volatility contribution).
- Equal Weighting (requiring neither average return nor volatility forecasts) as a benchmark.

He reforms portfolios every 20 trading days (approximately monthly) and estimates future risk metrics based on a rolling historical window of 500 trading days (approximately two years). Using daily returns over recent periods for stock and bond indexes and individual stocks segregated into several asset selection universes, *he finds that:* Keep Reading