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Quant Corner: What color is the little red schoolhouse?

August 17, 2015  | by Jess Gaspar

Investment Strategy | Risk Management

Welcome to the first installment of Quant Corner – where we take a closer look at investing and share insider tips, tricks from the trade, and break down common investing myths. Which brings us to the first topic: Dollar allocations ≠ risk allocation.

Let’s start with a question: Does a 70/30 portfolio have 70% of its risk in equities? While this question may appear to channel the old joke ”Is the little red schoolhouse red?”, the answer is clearly that a 70/30 portfolio does not have 70% of its risk in equity. Actually, it has virtually 100% of its risk in equity. This eBook explains why that is the case, and While investors may consider moving away from a fully diversified portfolio, they should resist the temptation.

Three Factors of Risk Allocation

Technically speaking, the answer comes down to three basic factors: the differences in volatility between equities and bonds, the low correlation between equities and bonds, and the resulting differences in the correlations of equities and bonds within the total 70/30 portfolio. By downloading the below eBook, you’ll have the opportunity to discover more on these three topics and examine the charts created to best illustrate the underlying principles.

Diversifying Portfolios

At Commonfund, one of our main objectives is to help clients expand and diversify portfolio exposure beyond the nearly pure equity volatility risk embedded in a simple 70/30 equity/fixed income portfolio. Of course, it should go without saying, we also strive to increase expected investment return.

We not only believe in, but advocate, a fully diversified approach to portfolio construction that includes not only equities and bonds but also alternatives like hedge funds, private capital and real assets. Our objective is to effectively use the multitude of levers at our disposal: investment diversification, manager selection, market timing and, another potential topic for a future Quant Corner, factor investing.

Disclaimer

Information, opinions, or commentary concerning the financial markets, economic conditions, or other topical subject matter are prepared, written, or created prior to printing and do not reflect current, up-to-date, market or economic conditions. Commonfund disclaims any responsibility to update such information, opinions, or commentary. To the extent views presented forecast market activity, they may be based on many factors in addition to those explicitly stated in this material. Forecasts of experts inevitably differ. Views attributed to third parties are presented to demonstrate the existence of points of view, not as a basis for recommendations or as investment advice. Managers who may or may not subscribe to the views expressed in this material make investment decisions for funds maintained by Commonfund or its affiliates. The views presented in this material may not be relied upon as an indication of trading intent on behalf of any Commonfund fund, or of any Commonfund manager. Market and investment views of third parties presented in this material do not necessarily reflect the views of Commonfund and Commonfund disclaims any responsibility to present its views on the subjects covered in statements by third parties. Statements concerning Commonfund’s views of possible future outcomes in any investment asset class or market, or of possible future economic developments, are not intended, and should not be construed, as forecasts or predictions of the future investment performance of any Commonfund fund. Such statements are also not intended as recommendations by any Commonfund entity or employee to the recipient of the presentation. It is Commonfund’s policy that investment recommendations to its clients must be based on the investment objectives and risk tolerances of each individual client. All market outlook and similar statements are based upon information reasonably available as of the date of this presentation (unless an earlier date is stated with regard to particular information), and reasonably believed to be accurate by Commonfund. Commonfund disclaims any responsibility to provide the recipient of this presentation with updated or corrected information. Past performance is not indicative of future results. For more information please refer to Important Disclosures.

Disclaimer

Information, opinions, or commentary concerning the financial markets, economic conditions, or other topical subject matter are prepared, written, or created prior to printing and do not reflect current, up-to-date, market or economic conditions. Commonfund disclaims any responsibility to update such information, opinions, or commentary. To the extent views presented forecast market activity, they may be based on many factors in addition to those explicitly stated in this material. Forecasts of experts inevitably differ. Views attributed to third parties are presented to demonstrate the existence of points of view, not as a basis for recommendations or as investment advice. Managers who may or may not subscribe to the views expressed in this material make investment decisions for funds maintained by Commonfund or its affiliates. The views presented in this material may not be relied upon as an indication of trading intent on behalf of any Commonfund fund, or of any Commonfund manager. Market and investment views of third parties presented in this material do not necessarily reflect the views of Commonfund and Commonfund disclaims any responsibility to present its views on the subjects covered in statements by third parties. Statements concerning Commonfund’s views of possible future outcomes in any investment asset class or market, or of possible future economic developments, are not intended, and should not be construed, as forecasts or predictions of the future investment performance of any Commonfund fund. Such statements are also not intended as recommendations by any Commonfund entity or employee to the recipient of the presentation. It is Commonfund’s policy that investment recommendations to its clients must be based on the investment objectives and risk tolerances of each individual client. All market outlook and similar statements are based upon information reasonably available as of the date of this presentation (unless an earlier date is stated with regard to particular information), and reasonably believed to be accurate by Commonfund. Commonfund disclaims any responsibility to provide the recipient of this presentation with updated or corrected information. Past performance is not indicative of future results. For more information please refer to Important Disclosures.