Asset strongallocationstrong under shortfall constraints - PLANCHET.pdfVIP

Asset allocationunder shortfall constraints Finding a balance between seeking gains and defendling against adverse performance. Martin L. Leibowitz and Stanley Kogelman R ver the long term, equity investors have ability, we can establish a ”shortfall constraint” to ,- 5 been richly rewarded for the risks that they have en- determine the maximum allocation to risky assets. ,- dured. For example, during the 1926-1987 period, the (See Leibowitz et al. [1990] for full details.) SP provided an annual return advantage of 6.8%, We also consider the sensitivity of the risky compared with long-term corporate bonds. Over asset allocation to changes in voliltility, equity risk sh0rte.r periods, by contrast, stocks actually under- premium, return threshold, and shortfall probability. performed cash on a surprisingly frequent basis. In Finally, we show how this methodology can be ap- particular, stocks have underperformed Treasurybills plied to multi-year investment horizons. over the past fifteen years in almost 35% of six- to eighteen-month time periods (see Salomon et al. THE EFFICIENT FRONTIER FOR AN EQUITYKASH PORTFOlLIO [1990]). Few professional investors are able to observe A portfolio manager with ,a well-established callmly and passively while high volatility buffets their horizon always has a continuum clf choices between portfolio’s value over the short run, and most