With a traditional 60/40 portfolio that comprises 60% stocks and 40% bonds, the weightings between stocks and bonds will be based on a fixed percentage of the dollar value of the portfolio. That is, the managers will allocate 60% of the portfolio's value in dollars to stocks and 40% to bonds. Other combinations, such as 30/70, will similarly depend on percentages of the portfolio's dollar value. Some portfolios that are more diversified may have smaller amounts allocated to a larger number of assets classes, such as 20% each to US stocks, foreign stocks, bonds, REITs and commodities.
The problem with this approach is that different assets have different levels of volatility, and there will be inevitably be an unbalanced allocation since asset volatility has not been taken into account in determining how much to allocate to each asset. In the 60/40 example, stocks, which are generally much more volatile than bonds, will dominate the portfolio performance.
A more balanced approach is to periodically measure the volatility of the assets in the portfolio and adjust the weightings assigned to each asset based on an estimate of future volatility. If a manager takes this approach, then so long as the volatility of the assets in the future is similar to the volatility in the past then the assets will be relatively balanced in the portfolio and the portfolio's return will be more representative of the returns of all the constituent investments.
I take a similar approach in sizing the positions in the Global Markets Program portfolios. When I put on a new position for the portfolio, I measure the historical volatility of the relevant market and use an algorithm to determine the size of that position that calculates a position size inversely related to the market's volatility. That is, a less volatile market such as a shorter term treasury note futures market will call for a larger position, while a more volatile market such as an emerging market currency futures market will call for a smaller position. The result should be a relatively well balanced portfolio.
The problem with this approach is that different assets have different levels of volatility, and there will be inevitably be an unbalanced allocation since asset volatility has not been taken into account in determining how much to allocate to each asset. In the 60/40 example, stocks, which are generally much more volatile than bonds, will dominate the portfolio performance.
A more balanced approach is to periodically measure the volatility of the assets in the portfolio and adjust the weightings assigned to each asset based on an estimate of future volatility. If a manager takes this approach, then so long as the volatility of the assets in the future is similar to the volatility in the past then the assets will be relatively balanced in the portfolio and the portfolio's return will be more representative of the returns of all the constituent investments.
I take a similar approach in sizing the positions in the Global Markets Program portfolios. When I put on a new position for the portfolio, I measure the historical volatility of the relevant market and use an algorithm to determine the size of that position that calculates a position size inversely related to the market's volatility. That is, a less volatile market such as a shorter term treasury note futures market will call for a larger position, while a more volatile market such as an emerging market currency futures market will call for a smaller position. The result should be a relatively well balanced portfolio.