Abstract
M.Com. (Financial Economics)
The portfolio allocation problem is characterised by two factors; risk and expected return. This is mainly explained by the Markowitz (1952) mean-variance framework. The frequency and severity of recent financial crises has led to an increase in calls for improved asset allocation methods in the asset management industry. Asset allocation strategies should protect investor capital and result in higher relative returns in turbulent times.
Modern portfolio theory has been heavily criticised (Lee, 2011; Roncalli, 2013) for failure to provide adequate diversification to protect fund managers during crises, hence the emergence of risk-based asset allocation methods that focus on portfolio construction based on risk and diversification. The crises led to poor performance of different portfolios and funds, especially those with high exposure to equities. Risk-based allocation methods try to achieve investors’ goals of safety and higher returns, irrespective of future market behaviour.
Six risk-based asset allocation strategies were explored and contrasted; Equally weighted, Risk parity, Most Diversified, Minimum Correlation, Minimum variance and the Minimum CVaR portfolio. This was done in an effort to find the method which performs better when investors have different investment goals. Predicted risk measures were applied as inputs in these risk-based asset allocation methods (i.e. a forward looking approach was taken). The study focused on comparisons of the risk-based asset allocation methods using forwardlooking risk measures in the South African market.
The main results of the study include the finding that risk-based asset allocation methods are effective in protecting investors’ capital and achieve higher returns than the market portfolio during crisis periods compared to other periods as expected. It was also found that the Minimum Correlation Portfolio performed better than all other risk-based asset allocation during the crisis period, which means it is the best risk-based asset allocation method to use during crisis periods in the South African market . There has not been a lot of studies on the perfomance of the Minimum Correlation Portfolio, and this result shows the need for a comprehensive study on all risk-based asset allocation methods in different countries/regions to determine which risk-based asset allocation technique is best for different regions.