ASSET ALLOCATION :

MANAGEMENT STYLE
AND PERFORMANCE
MEASUREMENT
BY WILLIAM F SHARPE
Kamal saeed
ID:5719580
Overview
Asset allocation accounts for large of variability
of return on typical investor portfolio.
Asset allocation is generally investor allocation
in number of asset class.
Overall return of portfolio of investor depend
on asset mix of portfolio which is regarded as
effective asset mix.
Measuring return on investor asset class
depends on how effective the fund manager
decision to pick asset which is measured with a
benchmark index such as s&p 500 overall
market return
 Here such kind of asset class is chosen to
analyze the performance of open end
mutual funds.
Mutual fund is basket of securities mixed
together to get a overall return accounting
from total return of each individual asset
class In the basket.
Open end mutual fund is active as asset
class can be change during the time
Close end mutual fund is set for once until
it expire.
Asset class factor models.
 The main assumption for asset class factor
models is simply for data description.
The non factor return for one asset eg e^ is
assumed uncorrelated. Factors are only
source for correlation.
Asset class is taken as special case of
generic type.
In each model each factor represent the
return on asset class and the sensitiveness
(Bij values) are summed to 1. Sensitiveness
is market response to return of the asset.
Evaluating Asset class factor
models
Asset class factor model is usefulness
depends on the asset classes chosen for
its implementation. It is taken as each
asset class is 1:Mutually exclusive 2:
exhaustive 3: have returns that Differ.
No identical securities would be added
into individual basket of asset class.
Efficiency of Asset class depends on uses
of models to be put and evaluated on the
basis of their ability to explain the returns
of assests useful metric is variance.
 To Evaluate the exposure of funds to changes in
the return of key asset classes the appropriate
measure is the collective ability of a set to
explain time series variability in the returns on
typical fund (e.g Mutual fund or separately
managed insititual account).Models designed to
explain specific portion of overall capital market.
For example when selecting equity factor one
must consider the ability of the selected factors
be explainable in time series variation. Most
stock models represents return on industry
groups/ economic sectors.
A twelve asset class models
In this asset class model author has used
twelve asset classes by a market
capitalization-weighted index of the return
on a large number of securities from capital
market to offshore capital market.
It is important to note that each index
represent strategy that could be followed at
low cost using index fund.
Each index has sufficient details for investor
to track the return with little error through
passive (index like) investment strategy.
 Stock with high book to price ration are
included in value stock index and
remainder in growth stock index.
Similar procedure also followed while
constructing medium and small
capitalization stock indexes which can be
non S&P 500. Ranked on the basis of total
outstanding market capitalization every
six months and dividing line drawn so that
aproxx imately 80% of the total value is
above the line and 20% below it.
 Most of the stock in the first group are
placed in the medium capitalization
index and most of the remaining stocks
in the small capitalization index, to avoid
excessive turnover in the composition of
these index of relatively illiquid stocks
any stock that has recently crossed over
the line a relatively small distance is
allowed to remain in its former index.
 Many of the difference in returns in US equity
mutual funds can be attributed to differences
in their exposures to these four asset classes.
There appear to be two key dimension along
which funds differ Value/growth and other
small/large .Each index can be considered as
capitalization weighted center of gravity of
the securities in its associated class indicate .
Any combination can be represented by a
poin in the area defined b the index location.
(eg the triangle.)
 Most of the research is done on long run to
find out whether value/growth stock or
small/large creates or vary of their returns
over time. Less attention is given to short run
variability of return. If Groups with similar
numbers of securities had been formed
randomly Fund exposure across these
dimension vary greatly, much of the variation
in fund returns in any given period can be
attributed to combined effects of their
exposures to these assets classes and the
realized returns on those classes.
Determining fund exposure
Traditional view of asset allocation assumes
that investor allocates assets among funds
each of which includes different and variety
of security in the funds.
Investor prefer key asset classes usually
know are function of the amount of the
investors portfolio invest in various funds
and 2 the exposures of each fund to the
assset clases the exposures of a fund to
various assest classes are in turn a function
of 1 and 2.
 The table shows example of trustee
commingled US portfolio (open end mutual
fund offered by vanguard). The colum
entitled unconstrained regression shows
results obtained applying equation 1.
The first twelve row show the resulting sloe
coefficient of (Bij values) expressed as
percentage. A portion of monthly variance
is explained by this equation inconsistency
and policy also attributed In fund
allocation.
 Constrained reports the results of a
multiple regression analysis
simmilar to first regression with one
added constraint The coeffficients
are required to sum to 100% the
reduction in R squared was slight
low.
Last one is unexplained variation in
returns.
Style analysis
Investor choice and allocation of money
to buy individual asset classes with
advise of fund manager it can be either
passive or active fund manager, active
fund manager changes asset class in
index overtime to beat the bench mark.
Investor may prefer value over growth
vice versa and also medium and small
cap corporation into asset class and the
percentage of allocation.
Exposure of unexplained
variance
Mutual Fund Style.
Mutual fund style consist of proportion of
asset classes included like individual asset
classes like value stock, growth or large
medium and small cap proportion of each
individual asset classes.
Some mutual fund may consist of large
proportion of value stock over growth (vice
versa) also it may consist of large or medium
small cap depends on fund manager choice
and monthly return active manager may
change the proportion according to the
market return to beath the benchmark
Style mainly on value stock with
little proportion of small stock.
Little change over time of return
across time.
Diversified mutual fund with
concentrations on various asset class
mainly onto growth stock
Increased return over time due to asset
class in mutual fund and properly chosen of
asset classes
Not only style selection of asset
does matter with the chart below mixed asset
classes with bonds and stock mixed
Utility stock fund that is invested
in both stock and bond and
passive
Growth and income utility fund that composes of both growth
and value stock slightly above proportion of value and also
holding cash in form of holding T bill
Holding small stocks may account for large return as in small
stock has high volatility but account to be more risky than
other asset classes
Balanced mutual fund holding each individual asset
class almost same proportion but the selection might
vary a bit.
High quality bond fund
Convertible bond fund: Bond that can be convert into stock
upon call by investor or fund manager depends on choice.
Overall effective mix of asset is important from the equation we can
prove that, effective asset mix represent the style of investor overall
portfolio for a multiple manager portfolio it is important than for an
individual fund
Performance Measurement we have seen many fund have different asset class in
their portfolio now we will see that which fund has performed and if they can have
beat the bench mark, avg accounts for how much beat or underperformed stv is how
much the return deviate from variance and tavg is satistically is significant or not.
Avg here seems like fund outperform more than 18% and stv
of risk is 1.4% and is satistically significant closer to zero.
Multiple fund performance having various asset class and different style and
selection can eventually outperform the bench mark associated with a index to
replicate the performance of fund such as s&p 500 overall return here return is
outperform by 57% std dev is 1.05 which is small and tv is satistically significant.
 The distribution of the average tracking error is far from typical while only out of
sample results can provide definate test of collective performance of mutual funds
the distribution is roughly normal with mean -0.074(-7.4 basis point) this roughly
consist with the hypothesis that average mutual fund cannot beat the market
Conclusion

An asset class factor model can help make order

out of noise that often attends in the investment
process it can provide a consistent view of
investment decision that investor make to
economy on information flows and exploit
comparative advantages, the style analysis
procedure describe in this article allow such a
model to be implemented economically at the very
least it can serve as value able supplement to
other methods to design investor to make portfolio
or achieve their goal in cost effective way.