You have the following advice from two different advisors.

Advisor 1: "Long term-asset allocation should be determined using an efficient frontier. Returns risks and correlations can be determined for each asset class from historical data. After calculating the efficient frontier for various locations, you should select the asset mix on the efficient frontier that best meets your fund's risk tolerance."

Advisor 2: "History gives no guide to the future. For example/everybody agrees that bond risk has increased above historical levels as a result of financial deregulation. A far better approach to the long-term asset allocation is to use your best judgment about expected returns on the various asset classes based on current. You should rely on your experience to determine the best asset mix and avoid being influenced by computer printouts. "

Advisor 1: Rebuttal: "Current market conditions are not likely to persist into the future and are not appropriate for long-term asset allocation decisions. Moreover, your use of judgment and experience can be influenced by biases and emotions and is not as rigorous a method as my efficient frontier approach."

Required:

Evaluate the strength and weaknesses of each of the two approaches presented above. Recommend and justify an alternative process [or asset allocation that draws from the strength of each approach and corrects their weaknesses.

Answer rating: 100% (QA)

For any investor it is of prime importance to wisely allocate the assets such that maximum return can be fetched for minimum risk To help the investors advisors provide their expertise to determine the best possible asset allocation depending on investors risk profile Advisor 1 From historical data we can easily find that various assets move in cyclic fashion and the correlation can be used to build a model that can reduce the risk and increase the return Although historical data cannot predict the future outcome but it can help to explore the outcomes Despite uncertainty in future outcomes it is better to make an investment decision rather than sitting on cash and losing on potential benefits Hence historical data is useful in decision making Subjective elements are involved in deciding the time frame and data to be used to make an analysis Based on the data set future movement of assets and volatility is assessed The relative movement of the assets are used to build portfolio and define the efficient frontier This efficient frontier can be used to determine asset mix with bearable risk of the investor ... View the full answer