The Hidden Cost of Volatility Drag: Understanding Robert Hayes' Strategic Advice Service (SAS)

The Strategic Advice Service (SAS) at BlackRock is a multi-disciplinary team that offers asset allocation strategy and Liability Driven Investing (LDI). As part of the "Multi-Asset Portfolio Strategies" (MAPS) team, they have an average of over 16 years' experience. Located in London, New York, Zurich, and Tokyo, SAS was established to provide thought leadership and client education.

Traditional Approach of Strategy Setting: Separating Strategy from Tactics

The traditional approach to strategy setting typically involves a three-stage process: strategy extrapolation from history, tactical asset allocation based on fair value assumptions, and strategic asset allocation using mean-variance optimization. However, separating strategy from tactics can be challenging due to the inherent difficulties in determining fair values and extrapolating historical data.

The Traditional Approach of Strategy Setting: Stage 3 - Security Selection Against Indices

One of the significant challenges in implementing a traditional approach is managing security selection against indices (SASI). This involves selecting securities that perform well relative to the market index, while avoiding those that have underperformed. However, SASI can be difficult to implement due to the constant changes in market conditions and investor behavior.

Enhancing Traditional Approach: Introducing the Black-Litterman Model

To address these challenges, the Black-Litterman model was introduced as a more flexible approach to strategy setting. This model employs market-implied risk and return forecasts, while also considering multi-period simulations of expected risks and returns. Additionally, differential equations (e.g., Campbell and Viceira) can be used to explicitly model asset class behavior.

Challenges for the Traditional Approach: The Reality of Model Differences

One of the significant challenges in implementing a traditional approach is that theoretical models often differ significantly from reality due to various assumptions. For example, normally distributed returns or quadratic utility functions are assumed, while constant correlations and risk aversion may not hold in practice. Practical challenges also arise when timing strategies or implementing them into market bubbles.

The Traditional Approach of Strategy Setting: Stage 2 - Tactical Asset Allocation

Tactical asset allocation (TAA) involves adjusting the asset allocation strategy based on specific investment objectives and constraints. This stage typically takes place before determining fair values and extrapolating historical data. TAA can be challenging due to timing considerations, as investors may need to rebalance or implement strategies into market bubbles.

The Traditional Approach of Strategy Setting: Stage 1 - Strategic Asset Allocation/Asset Liability Modelling

Strategic asset allocation (SAA) involves allocating assets across different classes and risk levels while ensuring that liabilities are adequately covered. This stage typically takes place after determining fair values and extrapolating historical data. SAA can be complex due to the need for mean-variance optimization.

The Traditional Approach of Strategy Setting: Common Misconceptions

One common misconception about strategy setting is that it should always follow a linear model with simple assumptions. However, real-world market conditions often require more nuanced approaches, such as using risk aversion and taking into account multiple time periods.

Enhancing Strategic Asset Allocation/Asset Liability Modelling: Considering Multi-Period Systems

To address these challenges, the Black-Litterman model can be used to explicitly model behavior of asset classes in multiple periods based on differential equations. This allows for more accurate modeling of risk and return assumptions.

The Traditional Approach of Strategy Setting: Scenario-Based Analysis

One effective way to improve strategy setting is by considering multiple scenarios and exploring different outcomes. By analyzing the potential consequences of various market conditions, investors can better understand how their strategies will perform in different environments.

Conclusion

In conclusion, a comprehensive analysis of Robert Hayes' Strategic Advice Service (SAS) reveals that traditional approach challenges are inherent difficulties in separating strategy from tactics, as well as common misconceptions about strategy setting and the need for more nuanced approaches. Enhancing SAS involves using multiple models, such as the Black-Litterman model, explicitly modeling behavior of asset classes in multiple periods based on differential equations, and exploring different scenarios to identify potential consequences.

BLACK-ROCK - STRATEGIC ADVICE SERVICE (SAS)

WHO WE ARE AND WHAT WE DO

BlackRock is a global leader in investment management, risk consulting, and wealth solutions. Our Strategic Advice Service (SAS) provides asset allocation strategy and Liability Driven Investing (LDI).

ASSET ALLOCATION STRATEGY AND LIABILITY DRIVEN INVESTING (LDI)

Our SAS offers tailored strategies to address specific client needs. We leverage expertise from actuarial, insurance, investment, economics, and modeling skills.

DIVERSIFICATION INTO ALTERNATIVE ASSETS

We diversify our portfolios into alternative assets such as real estate, commodities, and private equity.

MANAGER STRUCTURE AND RISK BUDGETING

Our managers are structured to manage risk effectively while achieving returns for clients. We implement robust risk budgeting systems.

ALPHA BETA ALLOCATION

We utilize alpha-beta allocation to optimize portfolio performance based on specific investment objectives.

ASSEMBLY OF TAILORIZED SOLUTIONS

Our team creates tailored solutions that address client needs, considering various market conditions and strategies.

Data as at 30 September 2009

THE HIDDEN COST OF VOLATILITY DRAG

Robert Hayes has over 16 years of experience in strategic advice. He provides asset allocation strategy and Liability Driven Investing (LDI) services to clients worldwide.

WHY MOST INVESTORS MISS THIS PATTERN

Most investors often miss the opportunity for alpha-beta optimization by failing to consider their individual circumstances and risk tolerance.

A 10-YEAR BACKTEST REVEALS...

Historical data reveals that a diversified portfolio with appropriate asset allocation can generate consistent returns over long periods.