AllocationADVISOR is an asset allocation and financial planning software tool included in your StyleADVISOR subscription. AllocationADVISOR is a separate program from StyleADVISOR, but portfolios (allocations) selected in AllocationADVISOR can be exported for use in StyleADVISOR.
What can I do with AllocationADVISOR?
Asset Allocation. The choice of asset classes to invest in – asset allocation – is generally regarded as the most important decision in the investment process. AllocationADVISOR uses mean-variance optimization to allocate assets and create efficient portfolios with the lowest risk for a given return. For more information about asset allocation, please see our article Asset Allocation.
Black-Litterman Model. In our next release of AllocationADVISOR users will have the ability to create return forecasts and make tactical asset allocation bets using the sophisticated Black-Litterman Model. The Black-Litterman asset allocation model, created by Fischer Black and Robert Litterman, is a state-of-the-art asset allocation model that enables investors to blend market equilibrium returns with their unique forecasts in a manner that results in intuitive, well-diversified asset allocations.
Portfolio Projections. AllocationADVISOR uses sophisticated statistical analysis to project possible future outcomes for the portfolios on the frontier. These projections help the user select the appropriate portfolio. They are also a great way to compare current and proposed portfolios.
Monte Carlo Simulation. AllocationADVISOR's Monte Carlo simulation tool combines portfolio return expectations, cash flows in and out of a portfolio and expected inflation to help you project future wealth.
Create and Export Presentations. AllocationADVISOR allows the user to create presentations with sophisticated graphs and tables. These graphics are easy to export to other programs.
AllocationADVISOR is included in the StyleADVISOR suite of software. The menu on the left provides links to pages that show and describe many of the StyleADVISOR and AllocationADVISOR graphs and tables. If you would like to see these same graphs with the manager of your choice and/or get a free demonstration version of the Zephyr suite of software you can click on the "Complimentary Analysis & Demonstration Software" link anywhere in this walkthrough.
What is Mean-Variance Optimization?
Mean-variance optimization was developed by Nobel Laureate Harry Markowitz as a way to create optimal portfolios based on risk and return trade-offs. The optimization uses return, risk and correlation forecasts to combine assets into portfolios that maximize return for different levels of risk. A graph of all of these optimal portfolios is called the efficient frontier. AllocationADVISOR builds efficient frontiers using Harry Markowitz's technique. With it you can examine efficient portfolios, compare selected portfolios to current holdings, view projections of future portfolio performance and more.
What is Monte Carlo Simulation?
Monte Carlo is a complex mathematical technique that has been used for many years in the space program, automobile manufacturing and in medical research. It estimates the probability of meeting specified goals in the (uncertain) future. In the investment world, Monte Carlo simulation helps you to understand the likelihood of achieving your goals given different investment portfolios while considering cash flows and inflation. You define the cash flows (withdrawals and deposits) and when they occur. Cash flows might be savings for retirement, buying a house, rent income, inheritance, tuition, and/or living expenses. By altering these cash flows, you can explore various “what-if” scenarios in your portfolio.
Who Uses AllocationADVISOR?
Managers, consultants, plan sponsors, financial advisors and financial planners use Zephyr software to create better client and prospect presentations that give them a competitive advantage. Zephyr software is also used to assist companies in gaining a better understanding of their investment management process.
What is included with AllocationADVISOR?
The Zephyr software package includes StyleADVISOR, AllocationADVISOR (an asset allocation program), unlimited support, Zephyr's consulting services and index, manager and mutual fund data.
Asset Allocation
Asset allocation is the most important step in the investment management process. AllocationADVISOR uses Harry Markowitz's mean-variance optimization to create a set of portfolios called the efficient frontier, which yield the highest expected return for a given level of risk. For more information about asset allocation, please see our article Asset Allocation.
As you move your cursor along the efficient frontier graph in AllocationADVISOR, the other graphs and tables in the workbook dynamically update to show the relevant statistics. This Data Cruise feature allows you to quickly see all of the information available for each portfolio along the frontier and to select portfolios based on that information. The Asset Allocation pie chart, for example, shows the percent allocations of the active portfolio.
To create an efficient frontier, you select the set of assets that represents possible investment choices. The Inputs table below shows a set of assets along with their expected return, expected risk and correlations. AllocationADVISOR automatically calculates historical projections using the vast databases provided with StyleADVISOR and AllocationADVISOR. Users can alternatively input their own estimates into AllocationADVISOR. Coming soon, AllocationADVISOR users will also be able to create inputs based on the sophisticated Black-Litterman model. For more information, see Black-Litterman Model.
Black-Litterman Model
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
In the next release of AllocationADVISOR users will be able to create Black-Litterman inputs. Our implementation of the Black-Litterman model is based on “A Step-By-Step Guide to the Black-Litterman Model: Incorporating User-Specified Confidence Levels” by Zephyr Associates’ Tom Idzorek, CFA. (For a copy of this research paper, please contact Zephyr Support at support@styleadvisor.com)
Portfolio Projections
Portfolio projections allow AllocationADVISOR users to project future performance for portfolios along the frontier. Users select an initial portfolio value and time horizon for these calculations. In addition, users can enter target returns and the allocation of a current portfolio.
AllocationADVISOR automatically calculates a set of projections for each of the portfolios along the frontier. AllocationADVISOR's flexible graphics allow you to view these statistics in different combinations for multiple time periods in both graphs and tables. The projections include:
Portfolio Comparisons
Compare Portfolios to Current Portfolio
The question of asset allocation often arises when investors are considering adding a new product or asset class into their portfolio, or are looking for a new mix of asset classes. AllocationADVISOR makes it easy to compare an existing portfolio to a portfolio selected from the efficient frontier. The table below, for example, shows the dollar differences of the projections for the current portfolio and the efficient portfolio (labeled Mix 1).
Compare Portfolios Across Different Time Periods
AllocationADVISOR allows users to select up to five portfolios along the efficient frontier. These portfolios can be compared to each other and/or to a user-defined current portfolio. Statistics are projected out over a variety of time periods so that investors have a good picture of possible outcomes.
Monte Carlo Simulation
AllocationADVISOR uses Monte Carlo simulation to simulate thousands of possible portfolio values in order to explore possible future outcomes. The Portfolio Value graph (below) shows how the portfolio value grows for a sample of simulation trials. The red lines on the graph reach zero. The table summarizes the range of possible portfolio values for different time periods and shows the user-entered cash flows.
AllocationADVISOR's Simulation Probabilities graph and table (below) show the probability of reaching user-defined wealth targets.
The Simulation Probabilities graph and table (below) can also display the probability of reaching a portfolio value of zero.
The Simulation Case table (below) shows the inputs that AllocationADVISOR used to create the simulation. All of these parameters are user-defined and can be customized to simulate different scenarios.
Create and Export Presentations
AllocationADVISOR is set up in a workbook format that allows users to create multi-page reports and presentations that contain the efficient frontier, projections and Monte Carlo analysis. AllocationADVISOR also allows you to export one page or the entire workbook to Microsoft PowerPoint or Word.
On the next few pages are some screen shots of different pages in a workbook.
