May 04, 2025

Historically we have estimated that the GOVT accounts for approximately 40% of the combined GOVT and S&P market capitalization. Therefore, if one is willing to define the GOVT and S&P as approximations of the market for liquid assets, then we should expect that a 60/40 allocation based on the GOVT, and S&P allocations will replicate the overall market allocation. But is this an optimal or desirable portfolio? We think so, the optimization process yields an efficient portfolio, defined as a portfolio that contains returns that have been maximized in relation to the risk levels that individual investor’s desire. Furthermore, in a market that is in equilibrium, where the number of winners and losers must balance, adding one additional asset class or stock does not increase the portfolio’s risk return ratio. This means the portfolio containing risky assets with the highest Sharpe Ratio must be the market portfolio. The results reported suggest that is the case. In other words, the 60/40 portfolio is a good proxy for the market portfolio, which is an efficient portfolio and as such denotes a great starting point in any portfolio strategy. A comparison of the differences in optimal allocation using the AGG and GOVT allows us to isolate the effects of the differences in the fixed income indices. Our underlying hypothesis is that the corporate bonds component of the AGG index adds an equity component to the fixed income results. As a result, the differences in allocation between the two alternatives are attributable to the equity component of the corporate bonds. This is an important result , first to the extent that the true equity allocation remains the same. The optimal AGG-S&P allocation will result in a lower S&P allocation than the optimal GOVT-S&P allocation. The reason for this is attributable to the corporate bonds’ equity component. If this is the case , those who use the AGG as their proxy for their fixed income may be inadvertently increasing the equity exposure of their portfolios

You must have an active account to view these reports. You may register for a trial here

Download Complete Report in PDF Format

Download Complete Report in Word Format