The Most Important Concepts in Finance
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The Most Important Concepts in Finance

Edited by Benton E. Gup

Anyone trying to understand finance has to contend with the evolving and dynamic nature of the topic. Changes in economic conditions, regulations, technology, competition, globalization, and other factors regularly impact the development of the field, but certain essential concepts remain key to a good understanding. This book provides insights about the most important concepts in finance.
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Chapter 9: Multi-asset investing: beyond the 60–40 ball park

Pankaj Agrrawal


The objective of this chapter is to extend classic investing, which is often limited to diversification within domestic equities or to a mix of equities and bonds (the traditional 60 percent stock and 40 percent bond allocation), to a wider array of assets that also include lower correlation non-equity assets. The ready availability of highly liquid index exchange traded funds (ETFs) on assets such as domestic equities, international equities, Treasury/sovereign bonds, real estate, gold bullion and foreign currencies has the potential to extend our availability set and the resulting risk-return (s_m) efficient frontier beyond what is possible with equity-only portfolios. This research, which utilizes the Morgan Stanley Capital International (MSCI) All-Country World Index (2004–16), is based on the Agrrawal (2013) paper (where the Russell 1000 Index was used as the market proxy) and shows that multi-asset investing is a worthwhile and profitable endeavor. This could take us a step closer towards meeting the all-inclusive, but elusive, “true market portfolio” (Roll 1977) and thinking “out of the equity box” that we seem to be perpetually trapped in. Investors stand to gain from the additional diversification made feasible by extending into a multi-asset class (MAC) portfolio-based covariance matrix. The shrinkage of the asset covariance structure (Choueifaty et al. 2013) and an overall reduction in the cross-correlations of the constituent assets (Willenbrock 2011) has the potential to produce efficient frontiers that would not be possible with pure equity-based portfolios. Eventually, that would be an efficiency gain for the investors. Traditionally the total risk in a security has been decomposed into market risk and idiosyncratic risk, also called systematic and unsystematic risks. However, in current intertwined and complex capital markets a portfolio of securities has a myriad of other risks as well.

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