Magazine article Modern Trader

Understanding Asset Allocation

Magazine article Modern Trader

Understanding Asset Allocation

Article excerpt

Understanding Asset Allocation By Victor Canto Prentice Hall, 2006 336 pages, $34.99

REVIEWED BY: NELSON FREEBURG

How does a portfolio manager achieve superior returns while methodically reducing risk? Consider the theoretical precepts and empirical findings of Victor Canto. Canto is a discerning student of price behavior and an analyst well-schooled in economic fundamentals. With a Ph.D. from the University of Chicago and wide experience as an investment manager, Canto brings scholarly insight and practical perspective to this text, which seeks to help managers maximize risk-adjusted returns through systematic asset allocation.

Canto develops several key points before presenting his final allocation model. One theme is that Federal taxation practices are a critical but largely overlooked determinant of stock prices.

Canto derides the well-known "Fed Model," which links stock prices with trends in bonds but ignores the tax structure. He attributes increased P/E ratios to the secular decline in tax rates through the last few decades more than by changes in bond yields.

Another principal finding pertains to the rotation in market leadership between large-cap and small-cap stocks. Canto finds that small-cap stocks outperform when: inflation is accelerating; taxation is expanding; and/or government regulation is intensifying. Large-cap stocks do best when these constraints on growth are subsiding.

Canto goes on to specify conditions that favor one asset class over another. …

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