The Difficulty in Predicting Optimal Regulation 28 Compliant Portfolios: Explained with the Benefit of Perfect Hindsight

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By J.C. Kloppers

Abstract

Due to the extreme uncertainty in the estimation of future expected returns on virtually all asset classes, portfolio managers are confronted with a virtually impossible task to construct optimal portfolios that will meet a return target; moreover, when the absolute value of this future return target is also uncertain, e.g. a CPI-linked benchmark. To highlight this difficult task, this paper investigates how optimal portfolios would have looked like over long periods of time, or over shorter-term rolling periods, all with the benefit of perfect hindsight. It is also shown that it is sometimes impossible to achieve those targeted returns, regardless of the selected asset allocation. The incorporation of hedge funds, and the potential benefit that they bring to portfolios, is also investigated. All is not lost; however, as it is shown that there is evidence from the literature that shows that optimal portfolios may be more stable over time, but it is beyond the scope of the current paper.

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