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.
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.