Wednesday, June 22, 2011

Morningstar Direct's New Asset Allocation Module Adds Fat-Tail Modeling Capabilities

Dr. David Krause, AIM program director, has been using Morningstar Direct for the past seven years to track the performance of the AIM Funds and other investments. Krause said, “I had an opportunity earlier this week to work with the new asset allocation program in Direct and it is an outstanding tool for portfolio planning. It has some powerful features that allow for traditional mean-variance modeling, but it also has the latest in non-normal distribution and fat-tail modeling. It is a significant enhancement.”

Many financial have used models produced by Ibbotson Associates, which is now a Morningstar subsidiary, for asset allocation methodologies. Now Morningstar Direct has incorporated Ibbotson’s current methodology and a new alternative to the typical approaches to mean variance optimization to meet asset allocation needs.

With the latest update of Morningstar Direct it is now possible to use conventional mean variance optimization (MVO) or new models that utilize “fat-tailed” distributions and use other return and risk metrics. Some key features in Morningstar’s release of Asset Allocation include:

×      Asset class modeling: Model asset class behavior with the option to use traditional log-normal or fat-tailed and non-normal distribution assumptions
×      Optimization: Find optimal asset allocation policies using traditional MVO or other return and risk measures, including conditional value at risk (CVaR) and downside deviation
×      Forecasting: Calculate the probability of future wealth and return outcomes

Dr. Krause continued, “I’ve always been impressed with Roger Ibbotson and his ability to link academia and the applied world. I look forward to learning more about this new tool in Morningstar Direct and how I can incorporate it into the AIM curriculum. This asset allocation tool was sorely needed before the financial crisis and market crash of 2008 – I believe many portfolios would have been well served had they employed this type of fat-tail asset allocation modeling.”

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