Identifying a recommended portfolio of financial products for an investor based upon financial products that are available to the investor

• US 7,016,870 B1
• Filed: 02/01/2000
• Issued: 03/21/2006
• Est. Priority Date: 12/02/1997
• Status: Expired due to Fees

• Current Assignee: Financial Engines
• Original Assignee: Financial Engines
• Inventors: Jones, Christopher L., Park, Ronald T., Watson, John G., Sharpe, William F., Scott, Jason S., Bekaert, Geert, Maggioncalda, Jeff N., Grenadier, Steven R.
• Primary Examiner(s): Dixon, Thomas A.
• Application Number:
  US09/495,982
• Time in Patent Office: 2,240 Days
• Field of Search: 705/35, 705/36, 705/37, 705/38, 705/30, 707/4, 707/10
• US Class Current: 705/35
• CPC Class Codes: G06Q 40/00 Finance; Insurance; Tax strategies; Processing of corporate or income taxes
• CPC Class Codes: G06Q 40/02 Banking, e.g. interest calculation or account maintenance credit or loans G06Q40/03
• CPC Class Codes: G06Q 40/04 Trading; Exchange, e.g. stocks, commodities, derivatives or currency exchange
• CPC Class Codes: G06Q 40/06 Asset management; Financial planning or analysis
• CPC Class Codes: G06Q 40/08 Insurance

Abstract

A financial advisory system is provided. According to one aspect of the present invention, return scenarios for optimized portfolio allocations are simulated interactively to facilitate financial product selection. Return scenarios for each asset class of a plurality of asset classes are generated based upon estimated future scenarios of one or more economic factors. A mapping from each financial product of an available set of financial products onto one or more asset classes of the plurality of asset classes is created by determining exposures of the available set of financial products to each asset class of the plurality of asset classes. In this way, the expected returns and correlations of a plurality of financial products are generated and used to produce optimized portfolios of financial products. Return scenarios are simulated for one or more portfolios including combinations of financial products from the available set of financial products based upon the mapping.

Claims

1. A financial advisory system comprising:

a forecasting means for generating return scenarios for each asset class of a plurality of asset classes based upon future scenarios of one or more economic factors;

a fund decomposition means, communicatively coupled to the forecasting means, for creating a mapping from each financial product of an available set of financial products onto one or more asset classes of the plurality of asset classes by determining exposures of the available set of financial products to each asset class of the plurality of asset classes;

a means, communicatively coupled to both the forecasting means and the fund decomposition means, for determining expected returns and volatility of returns for each of a plurality of portfolios on the efficient frontier based upon the mapping, each of the plurality of portfolios including combinations of financial products from the available set of financial products; and

a portfolio optimization means for identifying a recommended portfolio of the plurality of efficient portfolios that maximizes an expected utility of wealth for a particular investor based on the expected returns and the volatility of returns.

9. The method of claim 1, wherein said identifying a recommended portfolio assumes a buy-and-hold strategy.

2. A computer system comprising:

a storage device having stored therein a portfolio optimization routine to determine portfolio return scenarios for one or more portfolios including combinations of financial products from an available set of financial products and identify a recommended portfolio;

a processor coupled to the storage device to execute the portfolio optimization routine to generate asset class return scenarios, a mapping, portfolio return scenarios, and identify the recommended portfolio, where;

the asset class return scenarios are generated for each asset class of a plurality of asset classes based upon future scenarios of one or more economic factors;

the mapping associates each financial product of the available set of financial products with one or more asset classes of the plurality of asset classes, the mapping is generated by determining exposures of the available set of financial products to each asset class of the plurality of asset classes;

the portfolio return scenarios are generated by determining expected returns and volatility of returns for each of a plurality of portfolios on the efficient frontier based upon the mapping, each of the plurality of portfolios including combinations of financial products from the available set of financial products; and

the recommended portfolio is identified by determining a portfolio of the plurality of efficient portfolios that maximizes an expected utility of wealth for a particular investor.

3. A machine-readable medium having stored thereon data representing sequences of instructions, said sequences of instructions which, when executed by a processor, cause said processor to:

estimate returns for each financial product of an available set of financial products based upon the financial product'"'"'s sensitivity to movements of a plurality of predetermined economic factors by utilizing a factor model;

determine expected returns and volatility of returns for each of a plurality of portfolios on the efficient frontier for the available set of financial products, the plurality of portfolios each including one or more financial products of the available set of financial products; and

identify a recommended portfolio of the purity of portfolios that maximize a particular investor'"'"'s utility function at a predetermined time horizon taking into consideration the timing and amount of expected contributions and expected withdrawals, if any.

4. A method comprising:

one or more computer systems generating return scenarios for each asset class of a plurality of asset classes based upon future scenarios of one or more economic factors;

the one or more computer systems creating a mapping from each financial product of an available set of financial products onto one or more asset classes of the plurality of asset classes by determining exposures of the available set of financial products to each asset class of the plurality of asset classes;

the one or more computer systems determining expected returns and volatility of returns for each of a plurality of portfolios on the efficient frontier based upon the mapping, each of the plurality of portfolios including combinations of financial products from the available set of financial products; and

the one or more computer systems identifying a recommended portfolio of the plurality of efficient portfolios that maximizes an expected utility of wealth for a particular investor.

5. The method of claim 4, wherein the expected returns and the volatility of returns for each of the plurality of portfolios on the efficient frontier are determined analytically.

6. The method of claim 4, wherein the expected returns and the volatility of returns for each of the plurality of portfolios on the efficient frontier are determined based upon a simulation process.

7. The method of claim 4, wherein the particular investor'"'"'s utility function comprises a mean-variance utility function.

8. The method of claim 4, wherein said identifying a recommended portfolio assumes a constant-mix strategy.

10. The method of claim 4, wherein the available set of financial products represents a set of financial products offered through an employee-directed defined contribution plan.

11. The method of claim 10, wherein the available set of financial products comprises one or more of bonds, stocks, and mutual funds.

12. The method of claim 4, wherein said generating return scenarios for each asset class of a plurality of asset classes employs a model that incorporates a stochastic process that limits the prices on the assets and payoffs in such a way that no arbitrage is possible.

13. The method of claim 4, wherein the plurality of asset classes includes a core set of asset classes and a set of factor asset classes, and wherein the method further includes conditioning the factor asset classes upon the core asset classes.

14. The method of claim 13, wherein said conditioning the factor asset classes upon the core asset classes employs the following equation:

$r_{\mathrm{ij}}=a_i+{\mathrm{\beta <br><br>}}_{1<br><br>i}<br><br>{\mathrm{ST\_Bonds}}_i+{\mathrm{\beta <br><br>}}_{2<br><br>i}<br><br>{\mathrm{LT\_Bonds}}_i+{\mathrm{\beta <br><br>}}_{3<br><br>i}<br><br>{\mathrm{US\_Stocks}}_r+{\mathrm{\varepsilon <br><br>}}_i$

where,

r_it represents the return for a factor, i, at time t,

β

_ji represents the sensitivity of the factor i to core asset class j,

ST_Bonds_t represents the returns estimated for short-term US government bonds at time t,

LT_Bonds_t represents the returns estimated for long-term US government bonds at time t,

US_Stocks_t represents the returns estimated for US stocks at time t,

α

_i is a constant representing the average returns of factor asset class i relative to core asset class exposures, and

ε

_t is a residual random variable.

15. The method of claim 14, further including imposing macroconsistency upon the factor asset class returns by estimating α

_i relative to a known efficient portfolio.

16. The method of claim 15, wherein said imposing macroconsistency upon the factor asset class returns includes calibrating α

_i to be consistent with observed market weightings of the factor asset classes associated with the Market Portfolio.

17. A method comprising the steps of:

a pricing kernel step for generating return scenarios for each asset class of a plurality of asset classes based upon future scenarios of one or more economic factors;

a returns-based style analysis step for creating a mapping from each financial product of an available set of financial products onto one or more asset classes of the plurality of asset classes by determining exposures of the available set of financial products to each asset class of the plurality of asset classes;

a step for determining expected returns and volatility of returns for each of a plurality of portfolios on the efficient frontier based upon the mapping, each of the plurality of portfolios including combinations of financial products from the available set of financial products; and

a recommendation step for identifying a recommended portfolio of the plurality of efficient portfolios that maximizes an expected utility of wealth for a particular investor.

18. The method of claim 17, wherein the expected returns and the volatility of returns for each of the plurality of portfolios on the efficient frontier are determined analytically.

19. The method of claim 17, wherein the expected returns and the volatility of returns for each of the plurality of portfolios on the efficient frontier are determined based upon a simulation process.

20. The method of claim 17, wherein the particular investor'"'"'s utility function comprises a mean-variance utility function.

21. The method of claim 17, wherein said recommendation step assumes a constant-mix strategy.

22. The method of claim 17, wherein said recommendation step assumes a buy-and-hold strategy.

23. The method of claim 17, wherein the available set of financial products represents a set of financial products offered through an employee-directed defined contribution plan.

24. The method of claim 23, wherein the available set of financial products comprises one or more of bonds, stocks, and mutual finds.

25. The method of claim 17, wherein said pricing kernel step employs a model that incorporates a stochastic process that limits the prices on the assets and payoffs in such a way that no arbitrage is possible.

26. A method comprising:

one or more computer systems estimating returns for each financial product of an available set of financial products based upon the financial product'"'"'s sensitivity to movements of a plurality of predetermined economic factors by utilizing a factor model;

the one or more computer systems determining expected returns and volatility of returns for each of a plurality of portfolios on the efficient frontier for the available set of financial products, the plurality of portfolios each including one or more financial products of the available set of financial products; and

the one or more computer systems identifying a recommended portfolio of the plurality of portfolios that maximizes a particular investor'"'"'s utility function at a predetermined time horizon taking into consideration the timing and amount of expected contributions and expected withdrawals, if any.

27. The method of claim 26, wherein the expected returns and the volatility of returns for each of the plurality of portfolios on the efficient frontier are determined analytically.

28. The method of claim 26, where the expected returns and the volatility of returns for each of the plurality of portfolios on the efficient frontier are determined based upon a simulation process.

29. The method of claim 26, wherein the utility function comprises a mean-variance utility function.

30. The method of claim 26, wherein said identifying a recommended portfolio assumes a constant-mix strategy.

31. The method of claim 26, wherein said identifying a recommended portfolio assumes a buy-and-hold strategy.

32. The method of claim 26, wherein the available set of financial products represents a set of financial products offered through an employee-directed defined contribution plan.

33. The method of claim 32, wherein the available set of financial products comprises one or more of bonds, stocks, and mutual funds.