Portfolio Reallocation Analysis

RESEARCH | PRODUCT PROFILE

A customized solution to maximize returns

while controlling for multiple risks
Perhaps the biggest challenge you face as an institutional investor is to

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maximize portfolio returns while simultaneously managing multiple risk

Experience A global team of

highly experienced portfolio and risk
management specialists

Expertise Leading market insight

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Size One of the largest consolidated

crossing platforms in the industry

Scale Unique natural liquidity from

our leading custody, asset management
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Condence A trusted, unconicted

partner you can count on

exposures. State Street Associates Portfolio Reallocation Analysis (PRA)

helps you meet this challenge by employing portfolio optimization
technology that goes beyond the two-dimensional efcient frontier.
Instead, the PRA constructs a three-dimensional efcient surface that
simultaneously incorporates expected return, risk and tracking error
relative to your benchmark. This exciting innovation improves efciency
by signicantly reducing the need to impose arbitrary bound constraints
on the portfolio construction process.
The PRA is a fully customized asset allocation study incorporating
the latest innovations in the theory and practice of investing. In
addition to providing you with direct access to multi-risk optimization,
the report includes:

Expected return assumptions based on the Capital Asset Pricing Model

You Receive

Liabilities modeling (if applicable)

Asset class volatility and correlation assumptions for both normal

Portfolio allocations that control for

both absolute and relative performance
simultaneously

Stress tests that show how allocations

could perform during periods of market
turbulence

Continuous value at risk measurement so

you can evaluate your portfolios exposure
to loss throughout the entire investment
period, not just at the end

Risk budgets that show the contribution

of each asset class to the portfolios
risk exposure

and turbulent regimes

Multiple reallocations for both risk reduction and return

enhancement objectives

Stress tests for periods of market turbulence

Value at risk and exposure to loss estimates

The joint probability of being wrong and alone

Risk budgets to illuminate the risk contribution of each asset class

PORTFOLIO REALLOCATION ANALYSIS

Higher Returns, Lower Risk, Reduced Tracking Error

Regime-Dependent Risk Estimation

The PRA is particularly useful if your explicit objective is

George Chow, Mark Kritzman, Eric Jacquier and Chip Lowry

absolute return but your stakeholders are benchmark aware.

rst introduced this concept in the May/June 1999 issue of the

It can identify reallocations that offer lower tracking error

Financial Analysts Journal. They pointed out that measures of

without changing your expected risk and return. Or it can

risk, such as standard deviation and correlation, are not always

identify a superior portfolio allocation that offers higher returns

stable through time. By using a multivariate outlier methodology,

along with lower risk and lower tracking error.

they were able to separate historical returns into those associated with normal, quieter periods and those associated with

The analysis also goes beyond traditional value at risk to capture

periods of market turbulence.

risk exposure with two unique innovations developed at State

Street Associates: regime-dependent risk estimation to stress

Typically, crisis periods are characterized by higher volatilities

test optimal reallocations for periods of market turbulence, and

and correlations across asset classes. By partitioning data into

within-horizon risk measurement to measure exposure to loss

normal and turbulent periods, the PRA can help you

throughout the investment horizon and not just at its conclusion.

understand how your specic investments will respond to

turbulent market conditions.
Within-Horizon Risk Measurement

Identifying Periods of Market Turbulence

Kritzman and Don Rich introduced within-horizon risk measure-

Inputs to the portfolio construction process are carefully evaluated.

Risk parameters for periods of market turbulence are determined
using a sophisticated multi-dimensional analysis.

ment in the May/June 2002 issue of the Financial Analysts

Journal with an article that won a Graham and Dodd award.
The authors explained that investors typically think of risk as
the probability of loss at the end of their investment period.
The problem is that most investors really care about exposure
to loss throughout their entire investment period, not just at
the end. Within-horizon risk measurement often reveals that
your portfolios exposure to loss is substantially greater than
you may realize.

Multi-Risk Optimization

Put Our Expertise to Work for You

We incorporate three methods of optimization into your PRA:

More than 100 plan sponsors and institutional investors

worldwide have used the PRA to identify portfolios that
balance their risk of absolute loss against the need to track
a peer group or benchmark allocation. The PRA can also
incorporate liabilities into the optimization framework to give
pension plans the information they need to control surplus
risk and benchmark risk.

mean-variance, mean-tracking error and mean-variancetracking error.

The mean-variance method is the portfolio construction
process associated with Modern Portfolio Theory. It maximizes
expected return while minimizing your portfolios expected
variance of absolute returns
In contrast, the mean-tracking error method seeks to maximize

A Recognized Leader

your portfolios expected return while minimizing the expected

State Street Global Markets is a recognized leader in

investment research. Our commitment to innovation helps
us meet the constantly changing needs of our customers.

deviation of returns relative to its specied benchmark.

Multi-risk (or mean-variance tracking error) optimization is

When you partner with Global Markets, you partner with

a leader who:

an innovation in the eld of portfolio theory that maximizes

expected return while minimizing both absolute risk and
deviations from a specied benchmark. It allows you to

Offers a full spectrum of innovative portfolio and risk

management technologies and proprietary investor behavior
indicators through State Street Associates, our unique
partnership with renowned academics

Retains a team of leading academic and industry experts

who have published more than 50 research articles in
peer-reviewed journals

Empowers more than 500 institutional customers to develop

new perspectives, identify opportunities and manage risk
across different investment horizons

Incorporates the most advanced quantitative, analytical and

modeling techniques, enabling you to control risk exposure,
optimize performance, manage liquidity and cost objectives,
and monitor market turbulence

construct portfolio allocations that balance risk against your

desired tracking error target. This method of portfolio
construction which is almost always superior to classic
mean-variance optimization delivers a smooth trade-off
between return, risk and tracking error.

The Efcient Surface

The PRA relies on the most advanced optimization algorithms, including
multi-risk optimization, to address concerns about absolute and relative
volatility simultaneously, either on a surplus or asset-only basis.

STATE STREET GLOBAL MARKETS

State Street Global Markets provides specialized research, trading, securities

lending and innovative portfolio strategies to owners and managers of institutional
assets. Our goal is to enhance and preserve portfolio values for our customers
through original ow-based research, proprietary portfolio and risk management
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professionals to tap diverse sources of liquidity and provide cost-effective
solutions for our customers.
STATE STREET ASSOCIATES

State Street Global Markets research partnership with renowned academics,

State Street Associates, is creating a full spectrum of proprietary investor behavior
indicators and innovative portfolio and risk management technologies to empower
customers to develop new perspectives, identify opportunities and manage risk
across different investment horizons.
THE STATE STREET ADVANTAGE

For more information,

please contact:
Asia-Pacic
Justin Balogh
+81 3 4530 7560
jbalogh@jp.statestreet.com
Canada
Andrew Carrington
+1 416 956 2527
acarrington@statestreet.com
Europe, Middle East and Africa
Edward Pennings
+44 (0) 20 3395 7531
epennings@statestreet.com
United States
Peter Weiner
+1 617 664 8883
psweiner@statestreet.com

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