When people talk about asset allocation, they are usually referring to a mathematical model developed by Nobel Laureate Harry Markowitz called mean-variance optimization. Mean-variance optimization combines forecasts of expected return, expected risk and correlations between assets to create a set of portfolios that maximize return for a given level of risk. Investors often find that the resulting portfolios are unintuitive, highly concentrated and that the allocations are very sensitive to small changes in the forecasts.

Traditional Asset Allocation Typically Leads to Highly Concentrated Portfolios

The Black-Litterman model recognizes that the fault lies not in mean-variance optimization itself, but in the forecasts used. Instead of using historical numbers to predict future returns, the Black-Litterman model starts with the set of returns implied by equilibrium in the market. It then adjusts these returns for any views that the investors hold about sections of the market or relative future performance of different asset classes. The resulting portfolios are intuitive and diversified.

The Black-Litterman Model Results in Intuitive, Diversified Portfolios

AllocationADVISOR makes implementing sophisticated Black-Litterman Forecast model easy, and the Black-Litterman Forecast model makes harnessing the power of asset allocation possible.

For more information about how the Black-Litterman Forecast Model leads to diversified portfolios, see our newsletter article Black-Litterman: Asset Allocations You Can Actually Use!