Creating a simple asset allocation plan

Creating a simple asset allocation plan

This post is an example of how to make asset allocation plan with Adaquant Asset Allocation Suite. This is good reading especially for those that have just installed and opened the Suite and wondering how to start using the tool.

First step is to create a new clean simulation. While you can also change the settings of pre-configured simulations with ids 1-4, I would not recommend this – the Adaquant team might change the settings of these simulations in the data updates or future releases. When you create a new simulation, it gets an id of 1000 or above. This means it is user’s own simulation and the settings won’t be changed in future data updates.

However, you can press the small ok sign icon to set one of the simulations 1-4 as your default simulation (it turns green when it is set as default and gray otherwise). Click now the yellow plus button to create a new simulation. The settings of your default simulation are copied to the new simulation. This functionality is the same in all parts of the Suite. When you create for example a new estimate or cost profile, you can first set one of the existing ones as default to copy the settings from there.

If you are a first time user, I recommend you to do next the questionnaire. Select from the menu “Tools / Questionnaire”. The following window opens:

While you could do the questionnaire directly with this Questionnaire V1, I would recommend to create first your own Questionnaire. So press the yellow plus button to create a new questionnaire. Write to description whatever you wish such as “My Own Questionnaire”. You can also set your investment portfolio size, which has impact on the questionnaire questions. If you leave it empty, the default value in the questionnaire is 10’000. Then click button “Make Questionnaire”, answer all the questions, and finally press “Done” button.

Now you will see proposed targets for your asset allocation plan. In my case I have minimum target return 0% per annum with confidence level of 90%. This means that there must be at least 90% probability that the return is at least 0%. I also have a maximum drawdown target, it may not be worse than -35%. When I close the window, these targets are copied as input to the simulation.

If you are using the trial version of the software, you only have historic estimates available. However if you have bought the license, you can also use quarterly Adaquant estimates and cost profiles, or create yourself customized estimates. I use here the Adaquant estimates of USD investor as of 4th quarter 2017 (i.e. end of December 2017).

My investment horizon is for 10 years (setting “Period Years”), which I think is a good investment horizon to use as default horizon. First, the Adaquant estimates are done for 10 years horizon, and second, longer horizons don’t make that much sense because so many things will change anyway in the next 10 years of time. I rather keep the long-term horizon always in 10 years and rerun my asset allocation plan on annual basis always with the up-to-date input. However, if your investment time horizon is much shorter, you should use shorter time period.

By clicking button “Advanced Settings”, you will see some additional options. I recommend to leave them as they are by default.

You can also create your own investment portfolio in the tool (from the menu select Tools / Portfolio), and give it as input to the asset allocation plan simulation. This is especially useful if you already have a investment portfolio and would like to keep some of the investments as unchanged. You would then set your portfolio as input and set some main asset class / asset class weights fixed by checking “Lock To Current Weight”. However let’s do the simple asset allocation plan now without the portfolio.

For the main asset classes and asset classes, by checking “Include” you can define whether you want to include the main asset class or asset class to your asset allocation plan. You can also set “Minimum Weight” and “Maximum Weight” for each. In this simple plan I will leave them as they are configured for the USD based ETF investor.

The main window with all settings looks now like this (click image to see it larger):

Let’s make the asset allocation plan by clicking “Run Simulation”. It takes about two minutes to run and you can see the status in the progress window. Once the simulation is done, your asset allocation plan opens to the screen. It looks like this (click image to see pdf report):

If you look at the main asset class and asset class weights, you see that it is a very diversified and balanced asset allocation plan. Equities and long-term debt both get a bit more than 30% weight in the plan.

Looking at the returns, the expected average return per annum is 4.1%. Only with about 1% probability the return would be negative (between -1.2% and 0% per annum). This means that in about 1% * 1000 = 10 of the sample time series this plan would have caused negative returns. Since our confidence interval to have above 0% return was 90%, this plan easily satisfies the return target (confidence is here 100%-1% = 99%).

Looking at the maximum drawdown, the average expected maximum drawdown is -20.0%. In the worst cases the maximum drawdown is between -35% and -32.5%. Because the target maximum drawdown was -35%, this was to be expected. Looking at the distribution of drawdown, you can see that it has two peaks. Think it this way: in the next 10 years there is certain likelihood that there is financial crisis or similar that causes a big drop in stock markets. If this realizes, your maximum drawdown will be more negative at some point of the investment period. If it does not realize, then it will be less negative. Since the two peaks are about similar height, they have about the same probability to realize.

So what to do with this new asset allocation plan? You could implement it easily with Exchange Traded Funds (ETFs). Investing with ETFs is very cost efficient. In the last page of the report you can see that the estimated costs are only 0.14% per annum. If you think about investing in ETFs, take a look at Frequently Asked Questions “How to Find ETFs?”.

By |2018-08-10T13:04:29+00:00January 26th, 2018|