Volume 21, No. 3, Third Quarter 2023

Practitioner’s Digest • Vol. 21, No. 3

The “Practitioners Digest” emphasizes the practical significance of manuscripts featured in the “Insights” and “Articles” sections of the journal. Readers who are interested in extracting the practical value of an article, or who are simply looking for a summary, may look to this section.

Are 60/40 Portfolio Returns Predictable?

by: Jamil Baz, Steve Sapra and German Ramirez

Long-horizon asset class returns are reasonably predictable using simple models of expected return. However, equity returns over the last decade far exceeded model-based predictions. We posit a framework for the drivers of potential mean-reversion in equity returns. We believe increases in real bond yields and a decline in corporate profit growth are the most likely candidates to prompt an equity market correction.

Efficient Goal Probabilities: A New Frontier

by: Sanjiv Das, Daniel Ostrov, Anand Radhakrishnan and Deep Srivastav

In goals-based wealth management (GBWM), an investor looks to maximize the probabilities of attaining each of n goals over time. Because the goals are in competition for potentially limited financial resources, their relative importance must be specified, which we do by assigning utility weights to each goal. Given these weights, dynamic programming can determine both the optimal investment strategy and the optimal strategy for when to fulfill versus forgo each goal. This yields the optimal goal probabilities for fulfilling each goal. By altering the utility weights, we show how to generate the efficient goal probability frontier (EGPF), an (n − 1) dimensional hypersurface of the optimized goal probability combinations. Just as the classic efficient frontier in mean–variance portfolio optimization allows investors to understand the trade-offs under the best circumstances between their portfolio’s mean and variance, the EGPF allows the investor to understand the trade-offs under the best circumstances between the probabilities of attaining each of their goals—without needing to see or understand the goals’ underlying utility weights. We extend our EGPF framework to determine either the minimum initial wealth or the minimum of a one-parameter family of infusions over time that are needed to attain specified probabilities for each completely or partially fulfilled goal.

Asset Allocation with Non-Pecuniary ESG Preferences: Efficiently Blending Value with Values

by: Douglas M. Grim, Giulio Renzi-Ricci and Anna Madamba

The explosion of interest in ESG investing has yielded several quantitative frameworks that seek to incorporate non-pecuniary ESG preferences into conventional multi-asset portfolio optimization models. In this article, the authors specify an accessible approach that allows investors to simultaneously optimize for both pecuniary preferences (such as systematic, factor, and active risk aversion) and non-pecuniary ESG tastes in a way that avoids “one size fits all” solutions and arbitrary portfolio decisions. Using case studies, they demonstrate that the strength of non-pecuniary desires along with both pecuniary expectations and risk preferences are important determinants of the optimal portfolio choice.

The Determinants of Inflation

by: William Kinlaw, Mark Kritzman, Michael Metcalfe and David Turkington

The authors apply a Hidden Markov Model to identify regimes of shifting inflation and then employ an attribution technique based on the Mahalanobis distance to identify the economic variables that dynamically determine the trajectory of inflation. Their analysis enables policymakers to focus on the most effective tools to manage inflation, and it offers guidance to investors whose strategies might benefit from knowledge of the prevailing determinants of inflation. Their analysis reveals that as of February 2022, the most important determinant of the recent spike in inflation was spending by the federal government.

Trillions

by: Robin Wigglesworth • reviewed by: Javier Estrada

“Book Reviews” identifies important, and often popular, new books from a wide range of investment topics. Beyond providing a summary and review of the content and style of the books, “Book Reviews” seeks to contribute to a conscious, critical, and informed approach to investment literature.

Investment Management Lessons Learned From the Management and Mismanagement of Impending Bank Runs

by: Seoyoung Kim

“Case Studies” presents a case pertinent to contemporary issues and events in investment management. Insightful and provocative questions are posed at the end of each case to challenge the reader. Each case is an invitation to the critical thinking and pragmatic problem solving that are so fundamental to the practice of investment management.