Amherst Investment Office: A Data Science Sample
Jack Dove
Asset Allocation Analysis
According to BNP Paribas Wealth Management, asset allocation drives about 75 percent of portfolio returns, while the individual selection of different securities and specific investments represents 25 percent of the outcome of an overall portfolio. Endowments have to balance total returns and volatility in the form of risk-adjusted returns, and can do so by skillfully proportioning the types of investments they make.
The Amherst College endowment is comprised of 10 percent fixed income and cash and roughly 90 percent global equities, absolute return fund stakes, and real asset classes. In its latest report, the Amherst Investment Office compares its fund’s performance against a 60/40 Stock Bond Portfolio, which is the combined return of 60 percent S&P 500 (^GSPC) and 50 percent Bloomberg Barclays Aggregate Bond Index (AGG). The Amherst endowment (a roughly 90/10 split) outperformed the 60/40 benchmark by 4.3% from 2008-2018 with a slightly higher volatility level, which could be explained by the rougly 35% stocks and equities gap between the two portfolios. While a higher fixed income allocation might help volatility decrease, it will typically underperform equities in the long run.
To investigate this idea of asset allocation’s role in determining returns and volatility, I web scraped and analyzed ^GSPC and AGG security prices from November 22, 2010 to November 22, 2020 (10 years). I created six basic, imaginary funds following these asset allocations (^GSPC representing stocks, AGG representing bonds): 100/0, 80/20, 60/40, 40/60, 20/80, 0/100. After plotting the returns and percent returns of those portfolios, I calculated their final returns, volatility levels, and 10-year Sharpe Ratios, all based on monthly returns.
Total Returns
Endowments, despite their sometimes lower risk tolerance than other short-sighted funds, are still motivated to yield strong returns. Below is a chart displaying the values over ten years of each of the six created funds.
Unsurprisingly, the equity-loaded 100/0 fund outperforms the rest, leaving the solely fixed income portfolio at the bottom of the chart with the lowest returns.
Monthly Percentage Returns
An endowment fund for a college might need to withdraw money at any time with a high level of liquidity for scenarios like the COVID-19 pandemic. This chart shows the monthly percentage changes in value of the six funds.
While most data points are very tightly condensed, the peaks and valleys of the plot are tipped with red, suggesting that the purely S&P 500 fund boomed strongly during economic upticks and plunged during recessions, as shown in early-to-mid 2020. Meanwhile, the portfolios with more bonds stayed more consistent and landed typically in the middle of the other funds on the chart.
Overall Fund Comparison
As seen in the above charts, the funds with more equities had higher overall returns and higher levels of volatility, while the bond-loaded portfolios had lower values for both categories. Those differences are very visible in the below overall fund comparison table. I used Sharpe Ratio as a combined measure of both returns and volatility, which measured measures the proportion between cash-adjusted (subtracting out the interest rate of an almost risk free investment like government bonds) returns and the standard deviation of those monthly returns, as shown below.
\[ Sharpe{\;} Ratio = \frac{(R_p - R_f)}{ \sigma_p}\] \[ R_p: Portfolio {\;}Return \] \[ R_f: Risk Free {\;}Return \] \[ \sigma_p:Standard {\;}Deviation {\;}of {\;}Portfolio's {\;}Excess {\;}Return \]
Asset Allocation-Based Fund Comparison
| Portfolio | Return | Volatility | Sharpe |
|---|---|---|---|
| 100/0 | 172% | 3.98% | 0.21 |
| 80/20 | 148% | 3.39% | 0.22 |
| 60/40 | 123% | 2.73% | 0.24 |
| 40/60 | 97% | 1.99% | 0.27 |
| 20/80 | 71% | 1.19% | 0.34 |
| 0/100 | 45% | 0.86% | 0.31 |
The return and volatility levels had positive relationships with the percentage of asset allocation allotted to equities, as expected. Interestingly, the 20/80 split yielded the highest 10-year Sharpe Ratio at 0.34. This can be explained by its high proportion of fixed income leading to a low denominator of return standard deviation, with a middle-of-the-pack return that included 20 percent stocks.
Conclusion
The charts and overall comparisons suggest that asset allocation can significantly impact fund returns and volatility. This example is oversimplified, yet still supports the point made by BNP Paribas that fund performance can be dramatically impacted by asset allocation. While the 20/80 fund had the best Sharpe Ratio, it underperformed the 100/0 split by about 10,000 basis points, which, using my chosen starting fund size of $100 Million, is a massive amount of money that a school can turn into scholarships, infrastructure improvements, higher professor salaries, and more. It is up to individual funds to decide how to weigh and pursue the concept of risk-adjusted returns, and asset allocation is a good way to start.
Thank You
Your teams allows for a lot of my less finacially secure friend to attend, for a safe and well-tested COVID-19 bubble, for the hiring of smart professors who have shaped me, and more. Thanks for your hard work and time spent with me, and I hope I can help out and give back to your team this summer. Happy Thanksgiving! 