Can some one assist in giving the strengths and limitatiion of using the Black Litterman approach to asset allocation. I have read the CFA Manual and can seem to pick these out. Thanks
Bottom line; it extracts return and risk expectations from the current market to use for its model.
based on a market weighted global portfolio, you extract the returns of assets. this implies there is an equilibrium condition - I guess that you can use as a disadvantage. The advantage would be that returns are very important in getting the proper allocation - that is, the allocation will be very sesitive depending on the returns used
Isn’t another advantage of using a market weighted global portfolio that the results will be well-diversified?
^yeah…well diversified Black litterman also allows an adjustment to the weights based on market expectations
^ Ah, yes. The analyst can incorporate his views…
http://www.analystforum.com/phorums/read.php?13,974409,974771#msg-974771 Black-Litterman: Starts with the market portfolio and backs out the expected returns, risk premiums, covariances, etc implied by market prices, assuming market equilibrium. From there a Mean-Variance optimization is run using those inputs to generate an efficient frontier. [Also the manager can alter the model based on his/her views and expectations] Benefits - high level of diversification, overcomes weakness of MV which is the variability of estimated returns. Negatives - static approach, difficult to estimate returns.
Black Litterman: Achieve a more diversified asset allocation than MV (weakness - more complex to implement, final product is a MV optimization, static one-period approach) Avoid expected return input bias by using asset class return implied by global index (weakness - must estimate/ extract return from index, relies on historical values for var, covar)