Question

Which of the following statements is incorrect regarding Bucket based asset allocation?

Group of answer choices

A. Investors are able to change allocation of assets within, and across, each bucket based on changes in investment objectives.

B. A "Three Bucket" based asset allocation allows for better allocation of risk than a Risk Parity portfolio, since portfolio managers can choose the level of risk allocation or types of investments to each bucket.

C.Allocation of assets within each bucket can be done either through a quantitative methodology or a qualitative methodology which considers the inherent nature of each asset that is considered to be included in the portfolio

D.Asset allocation based on "Three Buckets" is inferior to Mean-Variance allocation that uses historical risk, return and correlation for each asset since the MV framework is backed by a sound theoretical framework.

E.Allocation to each bucket in a "Three Bucket" asset allocation is based on investors' investment objectives.

Answer 1

Bucket based asset allocation is an investment strategy that attempts to balance the risk versus reward by adjusting the percentage of each asset in an investment portfolio according to the investor's risk tolererance, investment time frame and goals.It is the asset allocation based on the cashflow and milestone needs of the investor.

The first bucket is is formed to meet the current or emergency requirements of the investor, and has an investment period of upto 3 years. It could have a asset class of fixed income including bank FD, ultra short term or any other lquid mutual funds. The main motive is to meet current cashflow needs.

The second bucket is usually for a period of 3 to 7 years and has a asset class of fixed income and safe equity and equity mutual funds. This may include bonds of PSU's, large cap mutual funds and other balanced mutual funds. The purpose of this bucket is to get constant returns with negligible volatility.

The third bucket is the one which creates wealth. This could include real estate, equity funds of small of mid cap or other volatile instruments.

Choosing the incorrect statement regarding bucket based allocation:

A. Investors are able to change allocation of assets within, and across, each bucket based on changes in investment objectives. This statement is correct as this is one of the features of bucket allocation.

B. A "Three Bucket" based asset allocation allows for better allocation of risk than a Risk Parity portfolio, since portfolio managers can choose the level of risk allocation or types of investments to each bucket. This statemnet is true.

C.Allocation of assets within each bucket can be done either through a quantitative methodology or a qualitative methodology which considers the inherent nature of each asset that is considered to be included in the portfolio. This statement is true.

D.Asset allocation based on "Three Buckets" is inferior to Mean-Variance allocation that uses historical risk, return and correlation for each asset since the MV framework is backed by a sound theoretical framework.. This state is incorrect as mean variance allocation relies of historial data and trends as a forecasting source. It is difficult to accurately predict the asset returns using theoritical historical data so this turns out to be a poor source. Little changes in return assumption can lead to inefficient portfolios as these estimates have much bigger impact on MV asset allocations. Thus, MV tends to form a highly concentrated portfolio thats does not include much diversification benefits. This theory also assumes the asset correlation to be static but in reality asset correlations move dynamically as the market cycle changes.

E.Allocation to each bucket in a "Three Bucket" asset allocation is based on investors' investment objectives. This statement is correct as this is one of the features of this method.