CFA Level III · Asset allocation
Portfolio sandbox: try an asset allocation
Set a strategic asset allocation and see its expected return, risk, Sharpe ratio, risk-adjusted utility and safety-first ratio, then compare it with the efficient frontier. The same calculations appear in Level III item sets and essays on asset allocation.
The starting capital market assumptions are illustrative, not forecasts. Change any return, volatility or correlation to match a question.
1. Your allocation
Weights are rescaled to 100% (now 100%). Long-only.
| Asset class | Weight % | Expected return % | Volatility % |
|---|---|---|---|
| Global equities | |||
| Global bonds | |||
| Real estate | |||
| Commodities | |||
| Cash |
Edit correlations
| Global equities | 1.00 | ||||
|---|---|---|---|---|---|
| Global bonds | 0.20 | 1.00 | |||
| Real estate | 0.60 | 0.30 | 1.00 | ||
| Commodities | 0.30 | 0.00 | 0.20 | 1.00 | |
| Cash | 0.00 | 0.00 | 0.00 | 0.00 | 1.00 |
2. Your portfolio
- Expected return
- 6.23%
- Volatility (standard deviation)
- 9.63%
- Sharpe ratio
- 0.335
- Risk-adjusted utility (λ = 4)
- 4.37%
- Safety-first ratio (R_L = 3.5%)
- 0.283
- Chance of returning less than R_L
- 38.9%
Utility U = E(R) − 0.005 × λ × σ² (percent). Safety-first ratio = (E(R) − R_L) ÷ σ; the shortfall chance assumes normally distributed returns.
3. Efficient frontier
4,000 long-only portfolios of these assets. The upper-left edge is the efficient frontier.
How to use it for Level III questions
- Enter the asset classes' expected returns and volatilities from the vignette, and their correlations if given.
- Set λ from the client's risk tolerance (higher λ means more risk averse) and R_L from the minimum return they need, for example their spending rate plus expected inflation.
- Compare the utility of each candidate allocation: the highest utility is the best mean-variance choice for that client. Use the safety-first ratio when the question is about avoiding a shortfall.
- Check the result against the constraints in the vignette (liquidity, legal, time horizon); the optimiser here only knows weights, returns and risk.
Study the theory
- Asset Allocation to Alternative Investments
- Asset Allocation with Real-World Constraints
- Capital Market Expectations, Part 1: Framework and Macro Considerations
- Capital Market Expectations, Part 2: Forecasting Asset Class Returns
- Overview of Asset Allocation
- Principles of Asset Allocation
- Active Equity Investing: Portfolio Construction
Frequently asked questions
What is the efficient frontier?
It is the set of portfolios that give the highest expected return for each level of risk (standard deviation). Portfolios below it are dominated: another mix of the same assets gives more return for the same risk or less risk for the same return.
How is risk-adjusted utility calculated in CFA Level III?
U = E(R) − 0.005 × λ × σ², with expected return and standard deviation in percent and λ the investor’s risk aversion. A higher λ penalises volatility more, so the utility-maximising portfolio moves towards less risky assets.
What is Roy’s safety-first ratio?
It is (E(R) − R_L) ÷ σ, where R_L is the minimum acceptable return. The portfolio with the highest ratio minimises the chance of returning less than R_L, assuming normally distributed returns.
Are these capital market assumptions real forecasts?
No. The starting returns, volatilities and correlations are illustrative numbers for practice. Edit them to match a vignette or your own assumptions; every result updates instantly.
Why are the portfolios long-only?
The sandbox does not allow short positions, which matches most strategic asset-allocation questions. With short selling allowed, the frontier would extend further.