Asset allocation is a failure
Asset allocation is NOT the primary driver of portfolio performance. Alpha is. Many claim relatively static percentages in various betas is all that matters but those academic papers are deeply flawed. The mistake has dominated portfolio construction for too long and wrecked wealth management and retirement plans the world over. Trillions are mis-invested due to such nonsense. Was nothing learnt from 2008?
The Greeks got it right: alpha comes before beta. If everyone invested 100% in one stock each, the "experts" would conclude that ONLY security selection drives returns! If investors flipped coins each year to be all stocks or all bonds then market timing becomes the SOLE factor. You only have to look at the risks and losses in traditional portfolios to see that "bet on betas" asset allocation urgently needs re-thinking. That applies to stocks, bonds, commodities and "hedge fund" clones. NEVER BET ON ANY BETA. Carefully choose specific securities or hire someone else with the time and skills to do it for the bargain basement fee of 2 and 20.
A stock and bond asset mix determines variation of returns only if you focus on beta. It's easy to debunk the asset allocation "axiom". If you encounter any "consultant" claiming that asset allocation accounts for over 90% of returns, don't walk away, run. Risk averse people invest in alpha. The true determinant of superior risk-adjusted returns is investment SKILL not percentages in UNSKILLED asset classes. It's the manager mix NOT the asset allocation. Check out the dire funded status of DB and DC pensions that gambled on betas due to incompetent advisors and conventional "wisdom".
It was a GREAT decade for the S&P. No beta for "passive" index funds but every day offered an opportunity set of fluctuating securities to capture alpha. It was an even better quarter century for the Nikkei. No beta since 1984 but vast alpha was generated from security selection and market timing by those with talent. Some "experts" say investors ought to have more in risky assets due to higher "expected" returns. Instead people would be wise to focus on 100% in skill. For those with liabilities to fund, intolerance of volatility or dislike of deep drawdowns, alpha is the prudent investment. Can't beat beta? Forget about beta.
In aggregate, stocks can underperform bonds for decades. 60/40 sounds prudent until rephrased as 90/10 risk. Why have a high risk appetite when unhedged equity indices NEVER compensate with sufficiently high reward even in bull markets. Last century's 8% return on 16% volatility was an insult but a last decade's negative total return with even more risk is absurd. Most bonds also don't reward enough for their risk. Do not go near index fund garbage. It is for speculators NOT fiduciaries.
Alpha beta separation is trendy but beta tends to swamp alpha as we saw in the downs and ups of 2008/2009. That led to the mistake inherent in the crazy concept called portable alpha. It was a beta-centric way of getting some investors into hedge funds but failed because it kept asset allocation front and center. It diluted the absolute return attribute and changed it into just another relative return index based product. The alpha beta separation idea still has too much risk budget in beta. But why bother with beta at all? "Cheap" beta is expensive considering its risk. Cost and risk conscious investors favor alpha. It's a cheaper source of return.
The more vituperative commentary on hedge funds, the more one should invest in alpha vendors. Why tie up precious capital in riskier beta when lower risk alpha is available? Better to identify mispricings and arbitrages than invest in "the market" itself. It is safer to minimize market exposure and analyze specific securities to buy and short sell that just gambling on benchmarks. Most portfolios are very beta biased while some investors implement a beta plus alpha model. The natural progression is to alpha only which has a much better efficient frontier. I do not understand why investors must surrender their wealth to the hazards of beta when superior alternatives exist.
Selecting the RIGHT betas at the RIGHT time is a form of alpha anyway. Choosing the WHICH and WHEN of asset classes takes as much talent and expertise as at the security level. I have no idea where "the markets" are going in the long term but will not take the chance of finding out. Asset and security selection, timing and hedging skill, though rare, are the only properties a conservative investor can rely on if they need adequate and consistent absolute returns. Beta is passive but do we really live in a world that rewards passivity in any activity? I don't think so which is why they are called ACTIVITIES. Alpha comes from acumen driven ACTION.
Successful investing is about leveraging informational, structural and analytical advantages or hiring those that have them. Let's look at portfolios that did well over long periods but didn't asset allocate, instead focusing on security selection or timing. A low frequency trading firm like Warren Buffett's Berkshire Hathaway identifies specific multiyear opportunities in currencies, commodities, stock and bond markets, derivatives and event driven special situations. In contrast the high frequency trading of Jim Simons' Medallion Fund times thousands of liquid securities over shorter holding periods down to microseconds. Producing alpha depends on your knowledge and technology edge applied to appropriate time horizons.
Beta bets drive many portfolios because that is what most investors do. It is like those who assume carbon is necessary for life because the science they know and only lifeforms they have analyzed are carbon-based. The anthropic principle applied to finance. It is false logic similar to the "all swans are white because every swan I've seen is white" phenomenon. Asset allocation fit nicely into the established body of theory which is why it remains popular despite its woeful weaknesses. Efficient, unbeatable markets imply the non-existence of skill! Choose beta because alpha is just "random" luck in a zero sum game? The much cited Brinson Hood Beebower paper has cost too many investors too much money. Beta people advocate index funds since they want you to invest in "the market". But the optimal way to achieve absolute returns at the total portfolio level is to be alpha-centric.
Beta vendors don't manage risk, don't market time and outsource ACTIVE security selection to benchmark construction firms. They even stay fully invested long only in bear markets! A beta-centric portfolio is where investors decide policy asset allocation and then hire managers to basically deliver the return from asset classes and hopefully a bit of alpha on top from tracking error constrained active mandates. Most long only funds have an R-squared with their benchmark over 70% - ie beta explains most of their returns. Alpha strategies and manager selection shouldn't be secondary but that is the result when beta bets dominate the allocation of investment capital.
Alpha vendors see a market of securities offering long/short opportunities in many time horizons within and between asset classes. An alpha-centric portfolio is where investors hire managers to analyze, trade and hedge for absolute returns. Of course you have to be good and work extremely hard to find alpha. Any manager that depends on beta is NOT running a hedge fund. A truly efficient portfolio does not pollute itself with beta. Dismissing all hedge funds is like avoiding all stocks because Enron, General Motors and Nortel fell to zero. Don't invest in bonds because some default and there is no such thing as a risk free rate? Nortel stock lost -100% while a Nortel bond is up +700% but most missed it.
Pure alpha sources do not fit well into the beta allocation process that some find so compelling. Since they are not assets, treating hedge funds as an asset class is wrong. The dispersion of returns across the industry is very high. So variable that AVERAGE performance has little meaning. 10,000 hedge funds, 10,000 strategies. People like to know if "hedge funds" were up or down each month. But what does that mean? Some made money and some lost money. Likewise I am often asked where I think "the market" is going. That is a beta question. Some stocks go up and others go down. Seek alpha.
Do I want "hedge funds" that outperform? No. I look for hedge funds that make money which is a very different target. I know that good hedge funds will have high risk-adjusted returns and bad ones will not. Alternative beta is just another beta and is therefore to be avoided. Most betas are becoming more correlated whether by geography or the equity, credit and real estate correlation to the economy. I am not concerned whether a hedge fund is "market neutral" or not. But it must be able to deliver absolute returns that are "economy neutral".
Alpha is the REAL diversifier because there are so MANY different ways of generating it. Focus on alpha if you want good returns regardless of the economy. Why pay attention to asset classes when investing in SKILL-BASED STRATEGIES makes more sense? Others are welcome to unhedged beta bets but for conservative investors like me beta with a bit of alpha is inferior to an ALPHA ONLY portfolio. Making money is simple: do the opposite of "Nobel" Prize economists.
The Greeks got it right: alpha comes before beta. If everyone invested 100% in one stock each, the "experts" would conclude that ONLY security selection drives returns! If investors flipped coins each year to be all stocks or all bonds then market timing becomes the SOLE factor. You only have to look at the risks and losses in traditional portfolios to see that "bet on betas" asset allocation urgently needs re-thinking. That applies to stocks, bonds, commodities and "hedge fund" clones. NEVER BET ON ANY BETA. Carefully choose specific securities or hire someone else with the time and skills to do it for the bargain basement fee of 2 and 20.
Bad science. Decide the conclusion you want, then find a data set you know IN ADVANCE will "confirm" it. If Brinson BHB had confined their absurd "analysis" to high frequency strategies obviously they would have found that ability at high frequency trading entirely drove performance! Therefore is it valuable to find that asset allocators' returns depend on asset allocation? Top performers focus on alpha so why waste time and money on beta. α yes, β no. How did those pathetic papers ever get through "peer" review? Would not happen in the hard sciences.
Sadly it has cost millions their retirement. Pensions keep doing what they have always done and got what they always get: reduced funded status. Betas will fail YOU in the long term. Famous studies reached BIASED conclusions because asset allocation is what the CHOSEN investors already focused on. In contrast smart investors pay no attention to asset class labels and focus on long short security selection and tactical timing. Good hedge funds analyze securities using skill. I have no interest in unskilled asset classes. They don't compensate for their risk even in strong bull markets.
It was a GREAT decade for the S&P. No beta for "passive" index funds but every day offered an opportunity set of fluctuating securities to capture alpha. It was an even better quarter century for the Nikkei. No beta since 1984 but vast alpha was generated from security selection and market timing by those with talent. Some "experts" say investors ought to have more in risky assets due to higher "expected" returns. Instead people would be wise to focus on 100% in skill. For those with liabilities to fund, intolerance of volatility or dislike of deep drawdowns, alpha is the prudent investment. Can't beat beta? Forget about beta.
In aggregate, stocks can underperform bonds for decades. 60/40 sounds prudent until rephrased as 90/10 risk. Why have a high risk appetite when unhedged equity indices NEVER compensate with sufficiently high reward even in bull markets. Last century's 8% return on 16% volatility was an insult but a last decade's negative total return with even more risk is absurd. Most bonds also don't reward enough for their risk. Do not go near index fund garbage. It is for speculators NOT fiduciaries.
Alpha beta separation is trendy but beta tends to swamp alpha as we saw in the downs and ups of 2008/2009. That led to the mistake inherent in the crazy concept called portable alpha. It was a beta-centric way of getting some investors into hedge funds but failed because it kept asset allocation front and center. It diluted the absolute return attribute and changed it into just another relative return index based product. The alpha beta separation idea still has too much risk budget in beta. But why bother with beta at all? "Cheap" beta is expensive considering its risk. Cost and risk conscious investors favor alpha. It's a cheaper source of return.
The more vituperative commentary on hedge funds, the more one should invest in alpha vendors. Why tie up precious capital in riskier beta when lower risk alpha is available? Better to identify mispricings and arbitrages than invest in "the market" itself. It is safer to minimize market exposure and analyze specific securities to buy and short sell that just gambling on benchmarks. Most portfolios are very beta biased while some investors implement a beta plus alpha model. The natural progression is to alpha only which has a much better efficient frontier. I do not understand why investors must surrender their wealth to the hazards of beta when superior alternatives exist.
Selecting the RIGHT betas at the RIGHT time is a form of alpha anyway. Choosing the WHICH and WHEN of asset classes takes as much talent and expertise as at the security level. I have no idea where "the markets" are going in the long term but will not take the chance of finding out. Asset and security selection, timing and hedging skill, though rare, are the only properties a conservative investor can rely on if they need adequate and consistent absolute returns. Beta is passive but do we really live in a world that rewards passivity in any activity? I don't think so which is why they are called ACTIVITIES. Alpha comes from acumen driven ACTION.
Successful investing is about leveraging informational, structural and analytical advantages or hiring those that have them. Let's look at portfolios that did well over long periods but didn't asset allocate, instead focusing on security selection or timing. A low frequency trading firm like Warren Buffett's Berkshire Hathaway identifies specific multiyear opportunities in currencies, commodities, stock and bond markets, derivatives and event driven special situations. In contrast the high frequency trading of Jim Simons' Medallion Fund times thousands of liquid securities over shorter holding periods down to microseconds. Producing alpha depends on your knowledge and technology edge applied to appropriate time horizons.
Beta bets drive many portfolios because that is what most investors do. It is like those who assume carbon is necessary for life because the science they know and only lifeforms they have analyzed are carbon-based. The anthropic principle applied to finance. It is false logic similar to the "all swans are white because every swan I've seen is white" phenomenon. Asset allocation fit nicely into the established body of theory which is why it remains popular despite its woeful weaknesses. Efficient, unbeatable markets imply the non-existence of skill! Choose beta because alpha is just "random" luck in a zero sum game? The much cited Brinson Hood Beebower paper has cost too many investors too much money. Beta people advocate index funds since they want you to invest in "the market". But the optimal way to achieve absolute returns at the total portfolio level is to be alpha-centric.
Beta vendors don't manage risk, don't market time and outsource ACTIVE security selection to benchmark construction firms. They even stay fully invested long only in bear markets! A beta-centric portfolio is where investors decide policy asset allocation and then hire managers to basically deliver the return from asset classes and hopefully a bit of alpha on top from tracking error constrained active mandates. Most long only funds have an R-squared with their benchmark over 70% - ie beta explains most of their returns. Alpha strategies and manager selection shouldn't be secondary but that is the result when beta bets dominate the allocation of investment capital.
Alpha vendors see a market of securities offering long/short opportunities in many time horizons within and between asset classes. An alpha-centric portfolio is where investors hire managers to analyze, trade and hedge for absolute returns. Of course you have to be good and work extremely hard to find alpha. Any manager that depends on beta is NOT running a hedge fund. A truly efficient portfolio does not pollute itself with beta. Dismissing all hedge funds is like avoiding all stocks because Enron, General Motors and Nortel fell to zero. Don't invest in bonds because some default and there is no such thing as a risk free rate? Nortel stock lost -100% while a Nortel bond is up +700% but most missed it.
Pure alpha sources do not fit well into the beta allocation process that some find so compelling. Since they are not assets, treating hedge funds as an asset class is wrong. The dispersion of returns across the industry is very high. So variable that AVERAGE performance has little meaning. 10,000 hedge funds, 10,000 strategies. People like to know if "hedge funds" were up or down each month. But what does that mean? Some made money and some lost money. Likewise I am often asked where I think "the market" is going. That is a beta question. Some stocks go up and others go down. Seek alpha.
Do I want "hedge funds" that outperform? No. I look for hedge funds that make money which is a very different target. I know that good hedge funds will have high risk-adjusted returns and bad ones will not. Alternative beta is just another beta and is therefore to be avoided. Most betas are becoming more correlated whether by geography or the equity, credit and real estate correlation to the economy. I am not concerned whether a hedge fund is "market neutral" or not. But it must be able to deliver absolute returns that are "economy neutral".
Alpha is the REAL diversifier because there are so MANY different ways of generating it. Focus on alpha if you want good returns regardless of the economy. Why pay attention to asset classes when investing in SKILL-BASED STRATEGIES makes more sense? Others are welcome to unhedged beta bets but for conservative investors like me beta with a bit of alpha is inferior to an ALPHA ONLY portfolio. Making money is simple: do the opposite of "Nobel" Prize economists.
© posted by Veryan Allen on 08:08
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