Choosing Market Weights for Black–Litterman Portfolios
Summary
The document asks how to set market capitalization weights for a Black–Litterman portfolio holding international and emerging-market equities, gold, long-term Treasury bonds, and real estate. Its central advice is not to use the market values of the ETFs themselves: ETF capitalization reflects only a small and changing share of the underlying securities or asset markets, rather than the total market portfolio.
Instead, it points to estimates of the amounts invested by all investors across broad asset classes. The cited allocation groups commodities, equities, real estate, government bonds, and non-government bonds. Since the example portfolio omits non-government bonds, the answer suggests reallocating that exposure among included assets while keeping the weights normalized to a total of 100 percent, and treating gold as a proxy for commodities. These broad estimates require judgment when mapping asset classes to the selected ETFs; the document does not give detailed calculations for each fund or a prescribed allocation within the omitted bond category.
Key ideas
- ETF market capitalization is not a reliable proxy for the size of the underlying asset market.
- Black–Litterman market weights can be based on estimates of total investor holdings across asset classes.
- The referenced allocation distinguishes equities, commodities, real estate, and government and non-government bonds.
- When an asset class is omitted, its weight must be reassigned among included assets to maintain a fully invested portfolio.
- Using gold to represent commodities is a simplifying substitution that requires judgment.
Tags
Full text
# Market Capitalisation Weights for Black-Litterman portfolio # Market Capitalisation Weights for Black-Litterman portfolio I am implementing the Black Litterman model for a few assets, in particular I am using five ETF: - EFA (EAFE stock index: developed markets outside US and Canada) - EEM (stocks from Emerging Markets) - GLD (Gold) - TLT (Long Term (20+ years) US Treasury Bonds) - IYR (US Real Estate Investments Trusts) My questions are the following: how can I compute the market capitalisation weights for these assets? Is it sufficient to divide the capitalisation of each ETF by a market index capitalisation? Should I normalize the weight in order that they will sum up to one? Thank you for your answers. ## Answer by nbbo2 (score 3, accepted) https://quant.stackexchange.com/a/54673 Do not use the capitalizations of the ETFs, they hold a small and variable proportion of the securities outstanding. Instead base your weights on the papers by Swinkels et al. which have tried to estimate the actual amounts invested by all investors (not just ETFs!) in various assets. Their latest paper is Historical Returns of the Market Portfolio, 2019 SSRN 297809 Here is a picture of the weights they use Commodities 1%, Equities 45%,Real Estate 6%, Govt Bonds 29%, non Govt Bonds 19%. You will have to make some adjustments, for ex. I see you do not include non-Govt Bonds. "Non government bonds" generally consist of Corporate Bonds, Mortgage Securities and some supra-national or sub-national govt organizations. (I suggest you use that 19% share for an additional allocation to Govt Bonds or split it into a mix of the other assets (mostly govt bonds but also a little bit of equities and perhaps real estate), so that the total weights still add to 100). For commodities you can substitute Gold.
Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)
This summary was written by Stratmill's research agent from the original; it is not a copy of the source.