Using the Black–Litterman Model: A View on Opinions

Abstract

We provide evidence on using the Black-Litterman (1991, 1992) asset allocation model and show that if investors form even partially correct opinions on small-cap and emerging market stocks, portfolio performance would have improved vis-à-vis no opinions. For the period 2006-2011, we show that the Black-Litterman expected returns for large-cap US stocks, the EAFE index, and the Bloomberg Barclays US aggregate bond index are highly correlated with future five-year returns in each of those assets. Expected returns on US small-cap and emerging market stocks have a low correlation with future returns. If an opinion was only partially correct on the latter assets, the resulting portfolios would have outperformed a market-cap-weighted benchmark portfolio. Thus, we conclude that investors may benefit more from investing resources in forming opinions on the future direction of small-cap and emerging market stocks relative to large-cap stocks.