Abstract
Is our BL/ABL allocation framework (Cheung, 2007c-e) applicable to active portfolio management? Yes – extracting the prior from the tilted allocation gives the active portfolio. This process requires PMs to work purely in the absolute return space.
However, many PMs allocate according to alpha signals rather than returns. In our current BL framework, there are pitfalls in blending such signals. This article formulates a practical Active BL model (the ‘αBL’) such that active strategies can also be constructed within the active space (i.e. alpha or residual return space).
With the two parallel approaches, issue emerges that the two consequent allocations can be arbitrarily inconsistent. By a discussion of view consistency conditions and absolute vs. active MV efficiencies, this article enables PMs to:
- combine active views with absolute views;
- compare active allocations constructed respectively based on the BL and the αBL; and
- choose freely between the two MV efficiencies.
A 4-asset worked example is used to illustrate.
However, many PMs allocate according to alpha signals rather than returns. In our current BL framework, there are pitfalls in blending such signals. This article formulates a practical Active BL model (the ‘αBL’) such that active strategies can also be constructed within the active space (i.e. alpha or residual return space).
With the two parallel approaches, issue emerges that the two consequent allocations can be arbitrarily inconsistent. By a discussion of view consistency conditions and absolute vs. active MV efficiencies, this article enables PMs to:
- combine active views with absolute views;
- compare active allocations constructed respectively based on the BL and the αBL; and
- choose freely between the two MV efficiencies.
A 4-asset worked example is used to illustrate.
| Original language | English |
|---|---|
| Publisher | Lehman Brothers |
| Publication status | Published - 2008 |