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Abstract
The authors build on traditional mean–variance optimization with a quantitative framework for combining the best of science and judgment in selecting an asset allocation for long-horizon investors such as endowments. The novelty of their approach lies in its ability to balance the desire for long-term returns with the need to manage short-term risk and funding constraints—important goals that are often in conflict. To reap the benefits of long-term risk premia, investors must be able to withstand occasional short-term painful drawdowns. The authors show how their unified approach can be used to examine how different combinations of asset classes, spending rates, and even alpha impact the policy portfolio over various planning horizons. The framework merges the science of portfolio optimization with a structure that informs sound judgment in determining an organization’s strategic asset allocation and spending policies.
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