Decentralized Downside Risk Management

Journal of Investment Management (JOIM), First Quarter 2011

Posted: 9 Apr 2011

See all articles by Andrea Reed

Andrea Reed

affiliation not provided to SSRN

Cristian Ioan Tiu

University at Buffalo; TIAA Institute

Uzi Yoeli

University of Texas at Austin - Department of Finance

Date Written: April 6, 2011


The process of risk management for institutional investors faces two challenges. First, since most institutions are decentralized in contrast to being direct investors in assets, it is difficult to separate the risks of the assets in the portfolio from the risks generated by the investment decisions by fund management. To address this issue, we propose a risk measurement methodology which calculates the risk contributions of individual securities and investment decisions simultaneously. This decomposition is applicable to any decentralized investor as long as its relevant risk measurement statistic can be additively decomposed. Second, statistics used to measure risk may not coincide with institution-specific investment risks, in the sense that the utility employed in asset allocation may be unrelated to the risk measure utilized. For example, an institution may do mean-variance asset allocation, but inconsistently measure the risk of the portfolio using Value at Risk. We apply this methodology to a particular type of decentralized investor, specifically, endowment funds where the relevant risk statistic is the downside risk of returns relative to actual payout levels, plus inflation. We show how downside risk can be decomposed and apply our simultaneous downside risk decomposition empirically on a sample of U.S. endowment funds. We find that an endowment's asset allocation to U.S. Equity, consistent with having the largest weight in the average endowment portfolio, generates almost half of the total endowment returns but almost 100% of the total portfolio downside risk. We further find that tactical allocations (or timing) have economically small contributions to both returns and risk. Finally, we find that the allocations to U.S. Fixed Income and to Hedge Funds as well as active investment decisions (except for tactical) contribute positively to returns, while reducing portfolio downside risk.

Keywords: risk management, asset allocation, downside risk, endowment funds

JEL Classification: G00

Suggested Citation

Reed, Andrea and Tiu, Cristian Ioan and Yoeli, Uzi, Decentralized Downside Risk Management (April 6, 2011). Journal of Investment Management (JOIM), First Quarter 2011, Available at SSRN:

Andrea Reed (Contact Author)

affiliation not provided to SSRN ( email )

Cristian Ioan Tiu

University at Buffalo ( email )

238 Jacobs Management Center
Jacobs Hall, North Campus
Buffalo, NY NY 14260
United States
7166453299 (Phone)

TIAA Institute ( email )

8500 Andrew Carnegie Blvd
Charlotte, NC 28262
United States

Uzi Yoeli

University of Texas at Austin - Department of Finance ( email )

Red McCombs School of Business
Austin, TX 78712
United States
512-471-1676 (Phone)

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