

Hoadley BlackLitterman Returns Estimator

Overview of the BlackLitterman Model 
One of the most sophisticated and widely used models for portfolio returns estimation and asset allocation is the BlackLitterman Bayesian asset allocation model. The BlackLitterman model was developed by Fischer Black and Robert Litterman at Goldman Sachs in the early 1990s.
The BlackLitterman model is designed to overcome the main weaknesses with Markowitz MeanVariance optimization: namely that the traditional method of estimating asset returns in isolation both from other assets and from the market as a whole usually leads to portfolios highly concentrated in a few assets  ie lacking diversification. Asset portfolio weights are very sensitive to even small changes in return estimates and this leads to portfolios which are risky and impractical to implement.
The Starting point for the BlackLitterman model is a portfolio with assets weighted according to their market capitalizations. Reverse optimization is used to back out the returns implied by the market weightings. These equilibrium expected returns  the market neutral reference point  are combined with user "views" about the absolute or relative performance of selected asset classes/sectors to produce revised ("blended") estimates of returns.
Revised estimated returns are then used to produce an optimal portfolio and, if required, an efficient frontier using the Hoadley Portfolio Optimizer.
Using
the BlackLitterman model leads to well diversified portfolios which
avoid extreme long/short positions, and the wild swings in asset allocation
weights which you
normally get from MVO when asset returns are changed, even slightly, in
isolation.
And importantly, the BlackLitterman model achieves this diversification without
the need to impose tight arbitrary constraints on asset weights during
portfolio
optimization.
The BlackLitterman model can be used for asset allocation, where "assets" are defined in terms of asset classes/sectors/countries etc. or for individual security selection. Whilst the principles for both asset allocation and security selection are the same, the BlackLitterman model is usually used for asset allocation using 820 asset rather than for allocating weights across a large number of individual securities within a portfolio.
The BlackLitterman model is not an
alternative to MVO but is complementary to it. BlackLitterman and
MVO are usually used together.
Using the Hoadley BlackLitterman Returns Estimator 
The Hoadley BlackLitterman Returns Estimator is an Excelbased software application that can be used by investors to estimate returns and allocate assets using the BlackLitterman model. The interactive nature of the application is designed to facilitate rapid scenario development and prototyping.
Using the Hoadley BlackLitterman returns estimation software involves three phases:
Estimating market equilibrium returns using reverse optimization. The inputs required are estimates of asset market weightings, volatilities and correlations, and an estimate of the overall "market" risk premium or return. Individual asset returns are then backed out using reverse optimization. 

Blending equilibrium returns with user views: User views about the absolute or relative returns of individual assets or asset groups are combined with the equilibrium (ie market implied) returns to produce a revised set of "blended" returns. 

Calculating optimal portfolio weights: The blended returns are then used to produce the optimal portfolio weights (ie which maximize the Sharpe ratio). 
Key features of the Hoadley BlackLitterman Returns Estimator include:
Flexibility in specifying user views: Views can be specified as absolute (eg "The return on US bonds will be 4.5% pa (80% confident)" or as relative (eg "US small caps and US large caps as a group will outperform equities in international developed markets and emerging markets by 1% (50% confident)". 

Graphical representation of returns and portfolio weights:
Original (equilibrium) returns and blended returns are shown
side by side on one chart. Market weights and
optimal portfolio weights incorporating user views are similarly
brought together on a single chart. 

Integration with the Hoadley Portfolio Optimizer: Data can be exported to the Hoadley Portfolio Optimizer with one button click for the production of an efficient frontier, possibly with asset constraints, and additional advanced analytics. 
The Hoadley BlackLitterman application
uses the BlackLitterman functions from the
Hoadley Finance Addin for Excel as
the calculation engine. The software application provides a convenient alternative to
using the BlackLitterman functions directly. The
application's VBA source code is not password protected and as such can be used as an example of
how to develop Excelapplications based on the Finance Addin for Excel.
Licensing 
The Hoadley BlackLitterman Returns Estimator application is included in the price of the Finance Addin for Excel.
When purchased under a private/personal license the number of assets that can be handled by the BlackLitterman functions is capped at ten. To handle more than ten assets a corporate/commercial license is required for businesses (Commercial licensing enquiries) or a "Pro" license upgrade for approved private investors ("Pro" licensing enquiries).
Software Environment 
This application requires Microsoft Excel (32bit or 64bit) running under Microsoft Windows. For detailed systems requirements, including supported versions of Windows and Excel see systems requirements.
Download the Hoadley BlackLitterman Returns Estimator 
The Hoadley BlackLitterman Returns Estimator is available for download to users who have purchased the Hoadley Finance Addin for Excel and are still within their one year free download period.