The myth of asset allocation

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Jan 3, 2006 1:16 pm

Let me know what y'all think of the following link.


http://www.financeware.com/Ruminations/AllocationMyth.PDF


I have some more links along these lines if you're interested.

Jan 3, 2006 1:18 pm

Don't tell mikebutler or bankrep. They love asset allocation.

Jan 3, 2006 2:36 pm

Higher risk equals high return.  How that is utilized is up to the
individual.  Asset Allocation is a sales gimmick - nothing
more.  It's a way for people to spend more time selling and less
time managing portfolios.  It's not a great way for the client to
get rich.



Look at EIAs and their popularity - same sort of high fee, low benefit product.

Jan 3, 2006 3:05 pm
dude:

Let me know what y'all think of the following link.


http://www.financeware.com/Ruminations/AllocationMyth.PDF


I have some more links along these lines if you're interested.



This kind of stuff is always interesting to debate, but this guy lost all credibility with me in his first footnote where he tried to make the case that dollar weighted as opposed to time weighed returns somehow undermined Asset Allocation. Note that he’s not an advisor, he simply sells software to those of us who are.<?:namespace prefix = o ns = "urn:schemas-microsoft-com:office:office" />


#474646; FONT-FAMILY: Verdana; mso-bidi-font-family: Arial">Financeware.com, in <?:namespace prefix = st1 ns = "urn:schemas-microsoft-com:office:smarttags" />Richmond, Va., wants to be an online partner to planners, according to its president and chief executive officer, David B. Loeper. He assures planners that he knows how to communicate with clients. "Most advisory services are backward-looking," he says. "They track performance records that show you what did happen but not what will happen." And Financeware.com, says Loeper, will solve this problem. Proprietary analytics take a client's financial data and calculate the odds of meeting goals. As a client's situation changes, the program keeps track of his or her progress toward these goals.


#474646; FONT-FAMILY: Verdana; mso-bidi-font-family: Arial">What sets his service apart from others, argues Loeper, is a move away from numbers -- a more client-centered approach instead of an "oversimplified" risk-vs.-return analysis. Risk is often measured in mathematical terms, "but not by clients, who simply say something like, I hate risk.'" So Loeper has tried to make his program more intuitive and user-friendly. He also provides Monte Carlo simulation with AASim software, designed to "model mortality and investment risk simultaneously." He has even done his own riff, or rather, rebuttal of Modern Portfolio Theory, called Modern Portfolio Reality, which takes into account market fluctuations and standard deviations over the course of years to create efficient portfolios.


#474646; FONT-FAMILY: Verdana; mso-bidi-font-family: Arial">Although the online questionnaires that start the planning process with Financeware.com are simple enough for clients to use themselves, the services are designed to be used in conjunction with a planner's advice. With a mix of humility and pride bordering on arrogance, the company's mission statement says, "We support the efforts of those who seek solutions for their clients and are willing to admit that they can improve on what has been done in the past."


Jan 3, 2006 3:08 pm
Beagle:

Asset Allocation is a sales gimmick - nothing more.



I've seen Nobel Prize winning research   called a lot of things before, but never a "sale gimmick".


Beagle:


Look at EIAs and their popularity - same sort of high fee, low benefit product.


You see EIAs and and use of asset allocation as the same thing? Just where's the "high fee" structure in asset allocation?

Jan 3, 2006 3:15 pm
dude:

Let me know what y'all think of the following link.


http://www.financeware.com/Ruminations/AllocationMyth.PDF


I have some more links along these lines if you're interested.



Also, if you read further through his article you come to the point where he says "That's not to say that asset allocation is bad...just incomplete". Well, golly, guess how you can make it "complete"? Well, you simply buy his software.... 

Jan 3, 2006 3:32 pm

I use DFA and there web site. Try it you and your clients will like it!  


http://www.dfaus.com/

Jan 3, 2006 3:59 pm
Beagle:

Asset Allocation is a sales gimmick - nothing more.  It's a way for people to spend more time selling and less time managing portfolios.  It's not a great way for the client to get rich.


You concentrate positions to get rich (ie. entreprenuership or stock options), you diversify to stay rich (ie. real estate, art, equities and bonds....not 1000 positions in 20 different SMAs ).  I've seen other advisors portfolios that have micro cap, mid cap value, large cap growth, etc, etc, etc. Clients complain that they get too much mail from confirms, proxys and annual reports for the measely 124 shares of this and 87 shares of that.


My clients are already rich when I contact them. Since I don't handle thier real property or art collection, I manage equities for them.  For me, and for them,  25 positions is enough create a meaningful portfolio.  In addition I add fixed income or international portfolios thru ETFs or mutual funds.   


Jan 3, 2006 4:14 pm
skeedaddy2:

 Clients complain that they get too much mail from confirms, proxys and annual reports for the measely 124 shares of this and 87 shares of that.



None of my clients get those unless they ask for them. I agree with you, they can be buried under paperwork, but again, only if they ask for it.


Jan 3, 2006 4:20 pm

Hey Mike, how were your holidays?

Jan 3, 2006 4:33 pm

As for asset allocation being nobel prize winning research:



Yes, it was prize winning research but even Markowitz has said that it
is being used incorrectly by the industry.  Every planner sells
their clients that they can optimize their portfolio to make it so much
better than you'd ever be able to do it on your own.  That's
BS.  Is standard deviation risk?  Yes if you believe the
industry, no if you are living in the real world.



It began as valuable research and turned into a sales gimmick. 
CAPM is great research but it's worthless in reality.   How
many wealthy people do you know who care where their portfolio lands on
the optimization frontier? 



Asset allocation is all fine and good, it's an important byproduct of
good portfolio management but it's a small detail people are selling as
nuclear science.



And yes asset allocation is expensive.  People are selling this
stuff in wrapped mutual fund programs charging 1.25% per year to do an
automatic rebalance of portfolios.  Show me a research report
where automatic reblancing of portfolios to optimize the asset
allocation of the portfolios leads to better investment returns.



Or maybe you are still selling your clients on that report that 91% of
their portfolios return comes from portfolio allocation?  Another
report full of false information.



It's just like Monte Carlo programs.   oohhhhh  yeah, that's a great selling took that means squat in reality.




Jan 3, 2006 4:57 pm

<?:namespace prefix = o ns = "urn:schemas-microsoft-com:office:office" />

Beagle:

As for asset allocation being nobel prize winning research:

Yes, it was prize winning research but even Markowitz has said that it is being used incorrectly by the industry. 


 



 


It can be used incorrectly, that doesn’t mean there’s something wrong with asset allocation, just that there’s something wrong with misusing it. You can misuse many great things.


 


Beagle:

Every planner sells their clients that they can optimize their portfolio to make it so much better than you'd ever be able to do it on your own.  That's BS. 



 


Any advisor who doesn’t think they can do better than the client on his own would do (and there are truckloads of studies about how poorly individuals do on their own) should leave the business.


 


Beagle:

 


Is standard deviation risk?  Yes if you believe the industry, no if you are living in the real world.



 


Of course sd, as a measure of how far a portfolio has/can move (no one’s ever complained to me about upside volatility  ) is a measure of risk.  I don’t know how you can say otherwise if you know what you’re talking about.

Beagle:

CAPM is great research but it's worthless in reality.   How many wealthy people do you know who care where their portfolio lands on the optimization frontier? 


 


Most that I talk to do. Especially when we review what happened to non-diversified portfolios since 1999 versus diversified ones.


Beagle:

Asset allocation is all fine and good, it's an important byproduct of good portfolio management but it's a small detail people are selling as nuclear science.


 



 


Could you explain this one further? What's "good portfolio management" as you define it?


 


Beagle:



And yes asset allocation is expensive.  People are selling this stuff in wrapped mutual fund programs charging 1.25% per year to do an automatic rebalance of portfolios. 


 



 


No, the program you’re talking about may be expensive, but that’s that particular vehicle, not asset allocation itself. ANd even comparing that to a EIA, as you did, is being less than serious


 


Beagle:

 


Show me a research report where automatic reblancing of portfolios to optimize the asset allocation of the portfolios leads to better investment returns.


 



 


You mean something beside MPT that details the risk of being too heavily weighted in a given sector, much less one that’s been “hot” enough lately to outgrow initial weighting given it? That should be pretty self explanatory. I will agree with you that auto rebalancing is little more than a specific discipline to force rebalancing.



Beagle:


Or maybe you are still selling your clients on that report that 91% of their portfolios return comes from portfolio allocation? 



 


That’s a good explain of the loose use of language that Markowitz was talking about. If you’re going to use his work you have to be specific about the conclusions he reached.


 


Beagle:



It's just like <?:namespace prefix = u1 /><?:namespace prefix = st1 ns = "urn:schemas-microsoft-com:office:smarttags" />Monte Carlo programs.   oohhhhh  yeah, that's a great selling took that means squat in reality.



 


Again, I disagree.  While you have to be specific in explaining to clients what Monte Carlo can and can’t be expected to do, but that doesn’t mean they’re useless. For all the faults in it it’s still far better than the predictability of buying into a “I’ll make you money, I have a system, never mind the underpinnings of how” sales pitch.


Jan 3, 2006 4:58 pm

Beagle, btw, I appreciate the civil tone. I'll try to do my part to maintain it

Jan 3, 2006 5:58 pm

That's an old article and when it was written (1999) there were many other similar ones along the lines of "the death of asset allocation".  At that time throwing darts at anything with a "dot com" got you 100% short term returns.  It was a difficult time for advisors using a planning/asset allocation approach, with clients saying "what you're doing for me is all fine and good, but my buddies are buying stocks & getting 70% gains.  Give me some of those!"


With the dot com bust that all changed, of course.  (Remember the jokes about how someone's 401K became a 201K?)  Planners/asset allocators didn't hurt their clients who stayed the course & they didn't burn up their books.  Our clients survived that bust, and they're still with us.  Those that might have taken some of their money away from us at the time are back (but with pennies on the dollar of what they took away).  We also got many new clients who fell into the trap (either themselves or through their brokers) of chasing the hot dots.


I certainly don't believe asset allocation will necessarily give anyone the best returns at any point in time.  But, for serious money at least for me it has proven to be a valuable method to preserve and enhance my clients' wealth, and to do so with a very manageable level of risk appropriate for each client.


Maybe there are those that can consistently pick the best performing asset class at any point in time, but it's not me and I have yet to find that person.

Jan 3, 2006 6:03 pm

[quote=dude]

Let me know what y'all think of the following link.





http://www.financeware.com/Ruminations/AllocationMyth.PDF



I have some more links along these lines if you're interested.

[/

QUOTE]



Hi Dude,



I contacted them about a year or so ago. I went over the questionnaire

they use and was immediately turned off. It asked the same question

phrased 5 different ways. Then the representative called me like maybe 5

or 6 times to get me to commit. Not for me.



I think we may have covered this on a previous occasion, but I disagree

with regularly culling back my winners to favor the underperformers in

order to keep a static allocation model.   I do the opposite, I eliminate

weaker holdings and let the better performers run. By the end of a year,

clients see a portfolio with a majority (95%) winners and they can't even

name "the mistakes along the way".



Hope you had a nice holiday.   
Jan 4, 2006 7:38 am
Duke#1:

That's an old article and when it was written (1999) there were many other similar ones along the lines of "the death of asset allocation".  At that time throwing darts at anything with a "dot com" got you 100% short term returns.  It was a difficult time for advisors using a planning/asset allocation approach, with clients saying "what you're doing for me is all fine and good, but my buddies are buying stocks & getting 70% gains.  Give me some of those!"


With the dot com bust that all changed, of course.  (Remember the jokes about how someone's 401K became a 201K?)  Planners/asset allocators didn't hurt their clients who stayed the course & they didn't burn up their books.  Our clients survived that bust, and they're still with us.  Those that might have taken some of their money away from us at the time are back (but with pennies on the dollar of what they took away).  We also got many new clients who fell into the trap (either themselves or through their brokers) of chasing the hot dots.


I certainly don't believe asset allocation will necessarily give anyone the best returns at any point in time.  But, for serious money at least for me it has proven to be a valuable method to preserve and enhance my clients' wealth, and to do so with a very manageable level of risk appropriate for each client.


Maybe there are those that can consistently pick the best performing asset class at any point in time, but it's not me and I have yet to find that person.



As usual, Duke says what I'd like to say, and in a far more diplomatic fashion. 

Jan 4, 2006 10:46 am

Standard Deviation shows volatility but is that the same as risk? 
For you maybe.  To me it's volatility and to me volatility isn't
risk, it's opportunity I try to utilize.  Warren Buffet and Steven
Markel have spoken on this recently.



In 1987-1989 I spent several hours per week with my finance professors
building a software program to build optimum portfolios using
MPT.  After 2 full years of backtesting and statistical work they
compared our data to that of another university doing very similar
work.  Both teams came to the conclusion that it didn't work very
well.  The result is a portfolio that performs well enough but the
fees and taxes (if applicable) will over power the long term
performance of picking an average mutual fund with lower expenses and
tax maintenance. 



When I did the study courses for the CFP, all but one of the
instructors had come to the same conclusion and were more interested in
selling financial planning and deteremined asset management was an easy
sell to pay the bills.



Asset allocation is all well and good and my clients receive it but I
use a form of tactical asset allocation with long term goals in mind to
outperform the market.  There have been several studies showing
that by limiting your asset classes and managing the asset allocation
accordingly, you increase your odds of achieving excess market
returns.  I'm not talking an outperformance of 5-6% per year, I'm
talking 1-3% per year over long periods of time, enough to offset my
fees and benefit the client.



My bashing of asset allocation is more along the lines of what
Skeedaddy is doing.  It looks good in theory and increases sales
but in about 10-15 years if you'll look back at the portfolio, the odds
are overwhelming that the portfolio has underperformed after taking
into account taxes and fees.  How is this buy what's hot and sell
what's down practice different than buy high / sell low?



My bashing of EIAs is more to do with the fact that the selling
practices are very similar to that of asset allocation selling. 
With this awesome product you will earn solid returns with zero
risk.  Except after fees the solid returns are a whisper of what
they could have been and over 10 years the zero risk guarantee is
virtually worthless.   Cut the commissions on EIAs in half and I
bet 95% of the sales would shift to a different product.  It's a
gimmick product that is easy to sell but isn't generally in the best
interest of the client.



And yes I will agree with you that a bad professional is probably going
to out perform the average professional just because they keep them
invested.  But history shows that a buy and hold investor that
buys an S&P 500 index fund has a pretty darn good chance of
outperforming any professional over 20 years after taking out fees and
taking taxes into consideration.



As for my portfolio management, I don't share it really - sorry. 
Back in 1991 I was introduced to an old guy in our area with an
absolutely awesome track record.  I paid him to teach me over the
course of a year how he invests and how he designs his
portfolios.  Best investment I ever made in my career but it
didn't turn me into a better salesman which is something I could use.

Jan 4, 2006 11:06 am

That's interesting. I've sold some EIA's to people who are happy with the prospect of earning an average annual return of 6-8%, tax deferred, with a principal guarantee. I'm happy with the 10% commission, paid out at 100%.

Jan 4, 2006 12:39 pm

Dirk,


I hope you're joking about the EIA.  Tell me how you can predict that the EIA is going to provide your quoted returns.  You know the market would most likely have to return 11% to 14% (compounding annual) over the EIA's "snapshot" period to get those returns if it is of the "quarterly averaging" style (I've done the math on a few of these things before).  Your figures are  most likely using past #'s which happen to cover one of the "richest" periods for stock market returns (last 20 years) in history.  Not likely to repeat, at minimum it is not a good idea to set your client's expectations so high


beagle,


Thanks for the comments, you are echoing my thoughts.  Although I'm somewhat of a hypocrite since I have used asset allocation as a selling tool extensively, but it's all I know. 


MikeButler


I understand where your coming from, believe me I was virtually brainwashed by the Morgan Machine (where I was trained) and they HAMMERED the asset allocation concept home. 


I'm beginning to get a little sceptical of what Wall Street wants us to sell though.  Wall Street cares about making as much money with as little trouble as possible.  Just like most things, if you were doing asset allocation 10 years ago before it was fad you did right, if you were doing the fad of the day you did wrong.  What is the fad of today?

Jan 4, 2006 1:00 pm
dude:

MikeButler


I understand where your coming from, believe me I was virtually brainwashed by the Morgan Machine (where I was trained) and they HAMMERED the asset allocation concept home. 



Give me some credit, Dude  I've been around the block and I didn't come to asset allocation due to brainwashing, I came to it when I saw people over and over again chase "hot dots", be they individual stocks or mutual funds. Asset allocation gets you away from "hot dots" and for all the faults it works well. To me it's like Churchil's comment on democracy, it's the worse form of govern, aside from all the others.


dude:

I'm beginning to get a little sceptical of what Wall Street wants us to sell though. 



You always should be. But remember, this one's a process, not a product.


dude:

Wall Street cares about making as much money with as little trouble as possible.  Just like most things, if you were doing asset allocation 10 years ago before it was fad you did right, if you were doing the fad of the day you did wrong.  What is the fad of today?



Sorry, but there's just no way to call asset allocation a fad. EIAs may be a fad, chasing "hot dots" is nothing more than chasing the latest, invogue investment style (Buffet wasn't an idiot in the 1990s, momentum style managers aren't idiots now), GMIB are surely fads.