The Transparent ABL Allocation: General Principles that Unify Strategy Combination, Factor Mimicking, Hedging, and Portable Alpha under One Equation

Authors: Cheung, W.

Publisher: Working Paper


This paper extracts the general principles of active portfolio selection: (1) subjective allocation rule (SAR)-based allocation and (2) minimum tracking error (MTE)-guided mimicking or hedging, through deriving and dissecting a transparent ABL model. It theoretically proves and empirically validates that SAR efficiently converts investor forecasting skill into proportional portfolio performance, and MTE guarantees efficient factor mimicking and systematic risk hedging. Since a range of portfolio-decision behaviours ultimately boils down to certain combination of allocation, mimicking, and/or hedging, this dissection modularises efficient portfolio construction and paves the way for the unification of portfolio theory and practice.

Source: Manual