I thought BL starts with weights, correlation and standard deviation to back solve the return. How come it starts with the return now?
Thank you!
If I had to guess you’re confusing this process with the process of establishing capital market expectations in general.
The unconstrained Black-Litterman Model (UBL) is a Bayesian process which starts with asset class weights based on the weights of a global portfolio. The manager then looks at each asset class weighting and adjusts its weight based on their market expectations.
The stronger the manager’s view on a given asset class the narrower the variance he or she gives to its expected return. This process allows the manager to express their views on asset classes/sectors while also resulting in a diversified portfolio (since it starts with a global benchmark).
The (regular) Black Litterman Model also produces diversified portfolios that use the manager’s views on sector returns. The difference compared to UBL is that it is more rigorously mathematical. The regular BL model starts with a global index with a correlation matrix for each asset class and then back-solves for the market’s expected return. From there the manager expresses opinions on each asset’s expected return and creates a new MVO weighted to incorporate those adjusted returns.capital market expectations in general is back solving for expected return
Makes sense now. Thank you!