{"id":21841,"date":"2020-04-22T13:15:19","date_gmt":"2020-04-22T12:15:19","guid":{"rendered":"https:\/\/traders-paradise.com\/magazine\/?p=21841"},"modified":"2020-07-22T13:44:49","modified_gmt":"2020-07-22T12:44:49","slug":"negative-numbers-in-asset-allocation","status":"publish","type":"post","link":"https:\/\/traders-paradise.com\/magazine\/2020\/04\/negative-numbers-in-asset-allocation\/","title":{"rendered":"Negative Numbers In Asset Allocation"},"content":{"rendered":"<div id=\"ez-toc-container\" class=\"ez-toc-v2_0_74 counter-hierarchy ez-toc-counter ez-toc-grey ez-toc-container-direction\">\n<div class=\"ez-toc-title-container\">\n<p class=\"ez-toc-title\" style=\"cursor:inherit\">Table of Contents<\/p>\n<span class=\"ez-toc-title-toggle\"><a href=\"#\" class=\"ez-toc-pull-right ez-toc-btn ez-toc-btn-xs ez-toc-btn-default ez-toc-toggle\" aria-label=\"Toggle Table of Content\"><span class=\"ez-toc-js-icon-con\"><span class=\"\"><span class=\"eztoc-hide\" style=\"display:none;\">Toggle<\/span><span class=\"ez-toc-icon-toggle-span\"><svg style=\"fill: #999;color:#999\" xmlns=\"http:\/\/www.w3.org\/2000\/svg\" class=\"list-377408\" width=\"20px\" height=\"20px\" viewBox=\"0 0 24 24\" fill=\"none\"><path d=\"M6 6H4v2h2V6zm14 0H8v2h12V6zM4 11h2v2H4v-2zm16 0H8v2h12v-2zM4 16h2v2H4v-2zm16 0H8v2h12v-2z\" fill=\"currentColor\"><\/path><\/svg><svg style=\"fill: #999;color:#999\" class=\"arrow-unsorted-368013\" xmlns=\"http:\/\/www.w3.org\/2000\/svg\" width=\"10px\" height=\"10px\" viewBox=\"0 0 24 24\" version=\"1.2\" baseProfile=\"tiny\"><path d=\"M18.2 9.3l-6.2-6.3-6.2 6.3c-.2.2-.3.4-.3.7s.1.5.3.7c.2.2.4.3.7.3h11c.3 0 .5-.1.7-.3.2-.2.3-.5.3-.7s-.1-.5-.3-.7zM5.8 14.7l6.2 6.3 6.2-6.3c.2-.2.3-.5.3-.7s-.1-.5-.3-.7c-.2-.2-.4-.3-.7-.3h-11c-.3 0-.5.1-.7.3-.2.2-.3.5-.3.7s.1.5.3.7z\"\/><\/svg><\/span><\/span><\/span><\/a><\/span><\/div>\n<nav><ul class='ez-toc-list ez-toc-list-level-1 ' ><ul class='ez-toc-list-level-4' ><li class='ez-toc-heading-level-4'><ul class='ez-toc-list-level-4' ><li class='ez-toc-heading-level-4'><a class=\"ez-toc-link ez-toc-heading-1\" href=\"https:\/\/traders-paradise.com\/magazine\/2020\/04\/negative-numbers-in-asset-allocation\/#Asset_allocation_is_one_of_the_most_efficient_investment_strategies_The_percentage_allocation_shows_the_level_of_risk_and_the_expected_return_What_if_the_numbers_are_negative\" >Asset allocation is one of the most efficient investment strategies. The percentage allocation shows the level of risk and the expected return. What if the numbers are negative?<\/a><ul class='ez-toc-list-level-6' ><li class='ez-toc-heading-level-6'><ul class='ez-toc-list-level-6' ><li class='ez-toc-heading-level-6'><a class=\"ez-toc-link ez-toc-heading-2\" href=\"https:\/\/traders-paradise.com\/magazine\/2020\/04\/negative-numbers-in-asset-allocation\/#By_Guy_Avtalyon\" >By Guy Avtalyon<\/a><\/li><\/ul><\/li><\/ul><\/li><\/ul><\/li><\/ul><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-3\" href=\"https:\/\/traders-paradise.com\/magazine\/2020\/04\/negative-numbers-in-asset-allocation\/#The_influence_of_derivatives_on_negative_numbers_in_asset_allocation\" >The influence of derivatives on negative numbers in asset allocation<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-4\" href=\"https:\/\/traders-paradise.com\/magazine\/2020\/04\/negative-numbers-in-asset-allocation\/#What_happens_if_the_futures_price_goes_against_the_trader\" >What happens if the futures&#8217; price goes against the trader?<\/a><ul class='ez-toc-list-level-3' ><li class='ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-5\" href=\"https:\/\/traders-paradise.com\/magazine\/2020\/04\/negative-numbers-in-asset-allocation\/#Lets_take_a_look_at_a_portfolio_example\" >Let\u2019s take a look at a portfolio example<\/a><\/li><\/ul><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-6\" href=\"https:\/\/traders-paradise.com\/magazine\/2020\/04\/negative-numbers-in-asset-allocation\/#How_the_negative_numbers_in_asset_allocation_occur\" >How the negative numbers in asset allocation occur<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-7\" href=\"https:\/\/traders-paradise.com\/magazine\/2020\/04\/negative-numbers-in-asset-allocation\/#Negative_returns_as_negative_numbers\" >Negative returns as negative numbers<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-8\" href=\"https:\/\/traders-paradise.com\/magazine\/2020\/04\/negative-numbers-in-asset-allocation\/#Do_negative_numbers_in_asset_allocation_have_any_positive_aspects\" >Do negative numbers in asset allocation have any positive aspects?<\/a><\/li><\/ul><\/nav><\/div>\n<h4><span class=\"ez-toc-section\" id=\"Asset_allocation_is_one_of_the_most_efficient_investment_strategies_The_percentage_allocation_shows_the_level_of_risk_and_the_expected_return_What_if_the_numbers_are_negative\"><\/span><img loading=\"lazy\" decoding=\"async\" class=\"alignnone size-full wp-image-21842\" src=\"https:\/\/traders-paradise.com\/magazine\/wp-content\/uploads\/2020\/04\/negative-numbers-t-1.jpg\" alt=\"Negative Numbers In Asset Allocation\" width=\"800\" height=\"534\" \/><br \/>\n<strong>Asset allocation is one of the most efficient investment strategies. The percentage allocation shows the level of risk and the expected return. What if the numbers are negative?<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h4>\n<h6><span class=\"ez-toc-section\" id=\"By_Guy_Avtalyon\"><\/span><a href=\"https:\/\/www.linkedin.com\/in\/guy-avtalyon-67941b54\/\">By Guy Avtalyon<\/a><span class=\"ez-toc-section-end\"><\/span><\/h6>\n<p><span style=\"font-weight: 400;\">If you wonder how it is possible to have negative numbers in asset allocation we will say the shorting on the asset may cause that.<br \/>\n<\/span><span style=\"font-weight: 400;\">For example, you have a long-short strategy with two classes only: equity long, and equity short. You can be sure that an equity short class will have negative numbers in asset allocation because all short investments are allocated under this class.<\/span><\/p>\n<p><span style=\"font-weight: 400;\">Asset allocation is important because it is an individual <\/span><span style=\"font-weight: 400;\">investment strategy<\/span><span style=\"font-weight: 400;\">. The numbers of stocks, bonds, commodities, cash show the level of risk and hence, how big returns an investor expects.<br \/>\n<\/span><span style=\"font-weight: 400;\">Investors use asset allocations in their factsheets that have to precisely represent their investment strategy. The asset allocation sums up to 100%,\u00a0 which means that the invested volume and cash all together build total net assets.<\/span><\/p>\n<p><span style=\"font-weight: 400;\">But if you build a portfolio that makes weightings of asset classes, you&#8217;ll have the negative numbers in your asset allocation. A good example comes from futures contracts, they can make your cash weighting appear negative.<\/span><\/p>\n<p><span style=\"font-weight: 400;\">This is connected to the leverage of the futures and the difference between the exposure and the actual book value of futures contracts. <\/span><span style=\"font-weight: 400;\">You know the future contracts are derivatives, right? Never mind. Let&#8217;s explain it in short.<\/span><\/p>\n<h2><span class=\"ez-toc-section\" id=\"The_influence_of_derivatives_on_negative_numbers_in_asset_allocation\"><\/span><b>The influence of derivatives on negative numbers in asset allocation<\/b><span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p><span style=\"font-weight: 400;\">Derivatives receive their value from the performance of underlying assets. The issuer can modify practically arbitrarily the exposure of derivatives to the price changes of the underlying assets. The changes in the market value of the underlying asset can be strong or weak. That is the so-called leverage effect. But, also it can be inverse. The point is that some small changes in the market value of the underlying assets may cause a really huge change in the value of derivatives.<\/span><\/p>\n<p><span style=\"font-weight: 400;\">Maybe the most popular derivatives are futures. Futures are contracts specified for the buying or sale of a financial instrument at a pre-arranged price in the future.\u00a0<\/span><\/p>\n<p><span style=\"font-weight: 400;\">For the buyer of a futures contract we say to go long, hence the seller goes short. Futures are traded on exchanges. The counterparty risk is close to zero. To guarantee that traders of a futures contract can cover possible losses at any time, they have to deposit an amount of the overall exposure of that futures contract. That is a <\/span><a href=\"https:\/\/traders-paradise.com\/magazine\/2020\/03\/gross-margin-how-to-calculate-and-why-it-is-important-for-investors\/\"><span style=\"font-weight: 400;\">margin<\/span><\/a><span style=\"font-weight: 400;\"> account.\u00a0<\/span><\/p>\n<h2><span class=\"ez-toc-section\" id=\"What_happens_if_the_futures_price_goes_against_the_trader\"><\/span><b>What happens if the futures&#8217; price goes against the trader?<\/b><span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p><span style=\"font-weight: 400;\">In such a case, the trader has to cover the losses on the margin account which is known as a margin call. But if the price goes in a trader&#8217;s direction, the trader will withdraw the profit from a margin account.<\/span><\/p>\n<p><span style=\"font-weight: 400;\">Therefore, the trader only places a part of the overall <\/span><a href=\"https:\/\/traders-paradise.com\/magazine\/2020\/04\/open-interest-strategy-and-how-to-use-it\/\"><span style=\"font-weight: 400;\">futures contract<\/span><\/a><span style=\"font-weight: 400;\"> exposure in cash on the table. So, there is leverage. For example, let\u2019s imagine a trader enters a contract with exposure in the underlying of $100.000. The requested margin for that trade, meaning the booking value of such a futures contract is $20.000. A 1% rise in the underlying asset or +$1.000,\u00a0 will result in a 5% rise in the booking value of the futures contract. So, the leverage in our example is 5.<\/span><\/p>\n<h3><span class=\"ez-toc-section\" id=\"Lets_take_a_look_at_a_portfolio_example\"><\/span><b>Let\u2019s take a look at a portfolio example<\/b><span class=\"ez-toc-section-end\"><\/span><\/h3>\n<p><span style=\"font-weight: 400;\">Let\u2019s assume you have a portfolio of $500,000 net assets. The total volume is in cash, so the portfolio allocation is 100% cash. Now let\u2019s enter into 10 of the futures contracts we mentioned prior, for example. The portfolio will consist now of $300.000 in cash and $200.000 invested in the futures contract. Expressed in percentages it will be 60% cash and 40% futures.<\/span><\/p>\n<p><span style=\"font-weight: 400;\">Is this an accurate picture? If we examine the booking value, this allocation is perfectly mathematically accurate. But should we base the allocation on the booking value solely? Of course not, because it is useless.<\/span><\/p>\n<p><span style=\"font-weight: 400;\">As the $200.000 booking value describes an exposure in the underlying of one million dollars, the allocation should display 60% cash and 200% underlying. This would show the real risk and anticipated potential return of this portfolio. But it is 260% in total?<\/span><\/p>\n<h2><span class=\"ez-toc-section\" id=\"How_the_negative_numbers_in_asset_allocation_occur\"><\/span><strong>How the negative numbers in asset allocation occur<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p><span style=\"font-weight: 400;\">We have only one test left now to understand negative numbers in asset allocation.\u00a0<\/span><\/p>\n<p><span style=\"font-weight: 400;\">It is expected the sum of all allocation positions in the calculation that use the booking value equals 100%. But if we use the interpretable exposure it doesn&#8217;t. It is a lot above 100%, actually, it is 260%! How to solve this issue that puts investors in a difficult situation? Speaking from the financial point of view, this increased exposure is based on the leverage. If you want the same exposure in the underlying assets, you will need cash. But if you don&#8217;t want to use the remaining cash,\u00a0 you have to lend the amount you need to invest in underlying assets.\u00a0<\/span><\/p>\n<p><span style=\"font-weight: 400;\">This means you have to balance the leverage by an additional position. That is known as &#8211; synthetic cash.<\/span><\/p>\n<p><span style=\"font-weight: 400;\">In our example, this will appear as an allocation of 60% cash, 200% underlying assets, and -160% in synthetic cash. But as managers of our portfolios, we like clear stats, so we can express our allocation as follows: underlying assets 200%,\u00a0 &#8211; 100% cash (synthetic cash included).<\/span><\/p>\n<p><span style=\"font-weight: 400;\">And can you see how the negative numbers in asset allocation arise? <\/span><span style=\"font-weight: 400;\">All without shorting.<\/span><\/p>\n<h2><span class=\"ez-toc-section\" id=\"Negative_returns_as_negative_numbers\"><\/span><b>Negative returns as negative numbers<\/b><span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p><span style=\"font-weight: 400;\">Negative returns are valuable in risk estimation. Investors have negative returns when the percentage of periodical return is below zero. To calculate this you have to divide the number of negative returns by the number of all returns over a given period. In this way, you can see the negative returns frequencies.\u00a0<\/span><\/p>\n<p><span style=\"font-weight: 400;\">For example, (note the numbers are for the purpose of this example only, they are not accurate) the negative return frequencies for 6-month returns from March 1960 to December 2001 were 2% for <\/span><a href=\"https:\/\/en.wikipedia.org\/wiki\/United_States_Treasury_security\"><span style=\"font-weight: 400;\">Treasury bills<\/span><\/a><span style=\"font-weight: 400;\">, 26% for long bonds,\u00a0 and 24% for the S&amp;P 500 Index.<\/span><\/p>\n<p><span style=\"font-weight: 400;\">The high negative return frequency for long bonds implies that bonds in the long periods present lower volatility than stocks. And this is very important info when it comes to the risk estimation.<\/span><\/p>\n<p><span style=\"font-weight: 400;\">The investors who recognize risk from the aspect of volatility, it might seem reasonable to believe that long bonds would have several more difficult years than stocks during a 41-year period. But this is a misconception.\u00a0<\/span><\/p>\n<p><span style=\"font-weight: 400;\">But recent data show investment returns might not be normally distributed. The normal <\/span><a href=\"https:\/\/traders-paradise.com\/magazine\/2020\/02\/asset-allocation-method-2020\/\"><span style=\"font-weight: 400;\">distribution<\/span><\/a><span style=\"font-weight: 400;\"> can minimize the influence of market shocks, for example, market corrections. Also, it doesn&#8217;t take into account the changes in returns within and between separate asset classes.<\/span><\/p>\n<h2><span class=\"ez-toc-section\" id=\"Do_negative_numbers_in_asset_allocation_have_any_positive_aspects\"><\/span><strong>Do negative numbers in asset allocation have any positive aspects?<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p><span style=\"font-weight: 400;\">There is some positive aspect of negative numbers also.\u00a0<\/span><\/p>\n<p><span style=\"font-weight: 400;\">We know it isn&#8217;t easy to stick with your long-term strategy when the markets fall sharply. But you can lose the bigger picture when such dramatic times come. Just think about the future, the time when you really will need that money. The majority of <\/span><a href=\"https:\/\/traders-paradise.com\/magazine\/2020\/02\/the-60-40-portfolio-is-dead-how-to-replace-it\/\"><span style=\"font-weight: 400;\">portfolios<\/span><\/a><span style=\"font-weight: 400;\"> have between 10 and 30 years time horizon. Stay focused on how many shares you have, don&#8217;t think what they are worth now. <\/span><\/p>\n<p><span style=\"font-weight: 400;\">Continue with regular investing, buy shares at lower prices, just keep investing even the share prices are dropping. Keep in mind that the markets are cyclical. So, what is bad today easily may become fantastic tomorrow. Markets are moving up and down, the negative numbers in asset allocation can turn into positive. Who can predict the time and how sharp the market can drop. The only thing is sure, the down markets always recover ultimately.<\/span><\/p>\n","protected":false},"excerpt":{"rendered":"<p>Asset allocation is one of the most efficient investment strategies. The percentage allocation shows the level of risk and the expected return. What if the numbers are negative? By Guy Avtalyon If you wonder how it is possible to have negative numbers in asset allocation we will say the shorting on the asset may cause [&hellip;]<\/p>\n","protected":false},"author":4,"featured_media":21843,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"content-type":"","_exactmetrics_skip_tracking":false,"_exactmetrics_sitenote_active":false,"_exactmetrics_sitenote_note":"","_exactmetrics_sitenote_category":0,"footnotes":""},"categories":[1016,1012],"tags":[1855,1853,1854,1856],"class_list":["post-21841","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-how-to-master-in-trading-advanced","category-traders-secrets","tag-negative-balance","tag-negative-numbers-in-asset-allocation","tag-negative-numbers-in-portfolio","tag-negative-returns"],"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v25.1 - https:\/\/yoast.com\/wordpress\/plugins\/seo\/ -->\n<title>Negative Numbers In Asset Allocation - Traders-Paradise<\/title>\n<meta name=\"description\" content=\"Negative numbers in asset allocation may be caused by the shorting on the assets. 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