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Creating a Strategic Asset Allocation and Active vs Passive Asset Allocation Strategy

Section 3: Execution, Part a - Strategic Asset Allocation

Section 3 (Execution, part a): Create a strategic asset allocation based on your goals and risk tolerance. Explain your rationale in your investing plan. Discuss the advantages and disadvantages of using an active or passive asset allocation strategy. (Note, in the next section, you will discuss the advantages and disadvantages of using an active or passive asset selection strategy.)

Start with your strategic (long term) asset allocation. Discuss why you have chosen the asset classes and weights you have. This should evolve over the course as we discuss the topic in class. Be sure to tie this back to the Investment Policy Statement and the investor’s objectives and constraints. Your asset allocation strategy should be based on heuristics at the beginning of the course, and should, by the end of the course, be a model based (Excel) plan built using the tools we develop in class. Your portfolio can (should?) consist of a core passive holding representing the market and an active portfolio component of a small (to keep it manageable) number of stocks selected using an active selection process and integrated (weighted) into your portfolio based on an advanced model. We will explore the Treynor-Black and Black-Litterman models, as well as the Markowitz model.

Section 4 (Execution, parts b, c, and d): Add a brief section to your investing plan that discusses your beliefs around efficient markets, how you will control or mitigate the effects of behavioural bias, and, if you plan to take advantage of the market’s behavioural bias, how you will do this. Discuss the advantages and disadvantages of using an active or passive asset selection strategy, tying this back to your views on efficient markets.

For the sake of this exercise, you must use an active approach regardless of how you would manage a real portfolio. I use a mostly passive security selection process but doing so in this assignment will limit your learning.  An active investing approach often utilizes both technical analysis and fundamental analysis. You learned how to conduct both in your Portfolio and Equity Analysis course, FNCE 3150. Explain your reasoning for your asset selections. Being as specific as possible, describe how you will decide when to buy an individual asset and how you will know when it is time to sell it.

For each asset in your portfolio, detail the analysis (technical and/or fundamental) that led you to the choice. As part of this analysis, you should use Excel to estimate the beta(s) of the asset using the CAPM and at least 1 other model (Fama-French 3 or 5 factor, Stone 2 factor, Carhart 4 factor, Paster-Strambaugh 4 factor, or Liu 2 factor model are examples). You should then forecast the factors for the next quarter and year (for example, the market risk premium for Canada might be forecast to be 5.6% for the 4th quarter of 2021 (the long-term average) and 5.4% for the next 12 month period.

At this point, you should build a portfolio in QuesTrade. This portfolio should reflect the work you have done above, that is, it should be appropriate for the type of investor, risk tolerance, and objectives and constraints. It should follow your asset allocation from section 3, and assets should be chosen using the methods you outline in section 4 above. Your initial weights should follow your initial plan, and your final weights should reflect your portfolio analysis model (be sure to turn in an annotated Excel spreadsheet with your actual model with the final draft of this project). As soon as you make your first purchase in QuesTrade, you should keep a spreadsheet that shows the value of each asset, including cash, in your portfolio. You should update the prices (values) of these assets daily, or at least every time you make a trade. Note that QuesTrade allows you to trade in both U.S. and Canadian Dollars. Pick one currency and place all of your trades in that currency. This will avoid the currency conversion issue that you would otherwise have to deal with.

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