Odd asset allocation. 20% UK 17% property 23% bond

System

dunstonh wrote: »

MSCI ACWI ALL CAP INDEX is also much higher up the risk scale.

Not being globally diversified is risky!

dunstonh

Economic wrote: »

Not being globally diversified is risky!

Correct. But not as risky overall. There are multiple risks. Each pulling or pushing in different ways. The pension fund will be looking at a target volatility range for that risk level and will balance risks.

Audaxer

dunstonh wrote: »

Correct. But not as risky overall. There are multiple risks. Each pulling or pushing in different ways. The pension fund will be looking at a target volatility range for that risk level and will balance risks.

Does that mean, say a 25% or higher UK equity allocation in a portfolio is deemed to be less volatile than a global portfolio with under 10% UK equity?

Malthusian

Audaxer wrote: »

Does that mean, say a 25% or higher UK equity allocation in a portfolio is deemed to be less volatile than a global portfolio with under 10% UK equity?

"Volatile" is generally measured objectively via standard deviation of recent returns. It isn't "deemed" volatile, if a 25% UK equity allocation results in a lower standard deviation of returns in £ terms than a global portfolio (which isn't unlikely due to the impact of currency risk), then it is objectively less volatile, in the sense that most people in the financial industry use the word.

Whether it is less risky is another question, and a more subjective one. Having a high allocation to one country introduces lost decade risk and other country-specific risks, and these risks can't be measured via backward-looking data. Fans of a UK equity heavy portfolio would counter that there are so many multinationals in the UK index that lost decade risk is much lower than it was in, say, Japan.

System

"The benefit from holding a more equally diversified portfolio of domestic and foreign assets is a lower volatility portfolio."
https://en.wikipedia.org/wiki/Equity_home_bias_puzzle

Audaxer

Malthusian wrote: »

"Volatile" is generally measured objectively via standard deviation of recent returns. It isn't "deemed" volatile, if a 25% UK equity allocation results in a lower standard deviation of returns in £ terms than a global portfolio (which isn't unlikely due to the impact of currency risk), then it is objectively less volatile, in the sense that most people in the financial industry use the word.

Whether it is less risky is another question, and a more subjective one. Having a high allocation to one country introduces lost decade risk and other country-specific risks, and these risks can't be measured via backward-looking data. Fans of a UK equity heavy portfolio would counter that there are so many multinationals in the UK index that lost decade risk is much lower than it was in, say, Japan.

In view of what dunstonh said, I wondered if a higher UK equity may be less volatile because of less currency risk, and was that why pension funds opted for more UK equity. I think in the years before internet investing, most UK investors would have had a much higher UK bias than today, and it probably didn't harm their long term returns too much.

Malthusian

Economic wrote: »

"The benefit from holding a more equally diversified portfolio of domestic and foreign assets is a lower volatility portfolio."
https://en.wikipedia.org/wiki/Equity_home_bias_puzzle

Meaningless. No information is provided in the article as to exactly what portfolios were compared or over what time period.

I would expect a 100% UK portfolio to be more volatile than a globally diversified portfolio because the former is shockingly undiversified by today's standards and subject to high specific risk. However, if you are comparing a global portfolio with 20% UK equities against a global portfolio with 5% UK equities, which is the subject of this thread, it could go either way. Depending on the random combination of currency fluctuations and recent market performance.

System

Malthusian wrote: »

Meaningless. No information is provided in the article as to exactly what portfolios were compared or over what time period.

I would expect a 100% UK portfolio to be more volatile than a globally diversified portfolio because the former is shockingly undiversified by today's standards and subject to high specific risk. However, if you are comparing a global portfolio with 20% UK equities against a global portfolio with 5% UK equities, which is the subject of this thread, it could go either way. Depending on the random combination of currency fluctuations and recent market performance.

There are references given in the Wikipedia article!

dunstonh

Audaxer wrote: »

In view of what dunstonh said, I wondered if a higher UK equity may be less volatile because of less currency risk, and was that why pension funds opted for more UK equity. I think in the years before internet investing, most UK investors would have had a much higher UK bias than today, and it probably didn't harm their long term returns too much.

If you think of a something being tugged in different directions by different things. Asset mix, currency risk, political risk, industry risk etc etc.

If you tug a bit harder in one direction then you have to give a bit more in the others. That is effectively what volatility based models do. They may say that by having a bit more in UK equity, they can a bit less in bonds and a bit more in global equity. If they go heavier in higher risk global equity (such as emerging markets, including asia) they would then have to go heavier in lower risk assets to compensate. This could see the middle range lose out.

There are usually constraints placed on maximum allocation to each area to prevent rather strange models for appearing. I have the software that allows this to happen and when you remove constraints, you get some quite unrealistic allocations.

Most treat UK equity as having lower volatility over the long term as historically that was the case. Going forward post globalisation, it is debatable whether that is the case or not. But then in day to day performance, bar any localised events, currency fluctuations do account for a lot of the volatility.

digannio

Thankfully only a small allocation to those two words that send a shudder down the spine...… absolute return!