Asset Allocation: Is Modern Portfolio Theory Dead? (2/2)

This is the second part of the summary of a session from the Money Management Institute’s 2012 Fall Solution Conference. You can read part 1 here.

Moderator:
  • Michael Jones, Chairman and Chief Investment Officer, Riverfront Investment Group
Panelists:
  • Colin Moore, Chief Investment Officer, Columbia Management, $339 billion AUM
  • Howard Present, President and Chief Executive Officer, F-Squared Investments
  • Steve Murray, Director of Asset Allocation Strategies, Russell Investment Group

How do fees affect your product decisions taking into consideration QE3 and a persistent low rate environment? Does paying 30-50 bps for bond allocations affect your product choices?

Murray said that fees do affect their product decisions, but that they always try to identify strong managers and the fees are a tradeoff versus the additional return that they’re expected to provide. Since Russell has a manager of managers structure allows them to move between managers with different fee levels as well as incorporate other products such as ETFs and mutual funds.

Fees have a higher impact when the product they’re attached to performs like Beta, Present ob served. Over the last decade, it was very difficult to extract value from equities as an asset class, while bonds appear that they will be difficult going forward. In 2008, the average target date fund was down 28%, so it didn’t matter if a manager was slightly above or slightly below that average. Relative performance in a down market is rarely appreciated by clients. You should be more aggressive with fees on beta products versus those that are designed to generate alpha, he said.

Does your philosophy of using low cost, transparent, liquid beta in the form of ETFs make it harder for your products to coexist on a sponsor platform alongside more traditional ones? — Randy Bullard

Jones proposed that their philosophy, which combines stocks, bonds and ETFs into dynamic allocation solutions is complementary to the more traditional solutions (like Russell). there is more than one way to create value besides picking stocks from a narrow slice of an asset allocation pie chart. They added another value dimension by adjusting the amounts allocated in each slice of the market based on the prices and momentum in each asset class. It’s not an either or decision to use their products or traditional. There’s a philosophical diversification that can be complimentary instead of competitive. Continue reading

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Asset Allocation: Is Modern Portfolio Theory Dead? (1/2)

This is a summary of a session of the Money Management Institute’s 2012 Fall Solution Conference.

Moderator:
Michael Jones, Chairman and Chief Investment Officer, Riverfront Investment Group
Panelists:
Colin Moore, Chief Investment Officer, Columbia Management, $339 billion AUM
Howard Present, President and Chief Executive Officer, F-Squared Investments
Steve Murray, Director of Asset Allocation Strategies, Russell Investment Group

This was an interesting discussion since each of the panelists approach asset allocation from a different perspective.  Jones believes that modern portfolio theory (MPT) is dead and that asset allocation should be more fluid and dynamic so they shift the pie chart around.  Riverfront has a simple methodology, which states that the price you pay is the number one determinate of the upside potential and downside risk of an investment.  They feed the price into a proprietary optimization process to create a portfolio that tries to make money in a worst case scenario while still maximizing the upside potential.

Moore agrees that the standard process is deeply flawed and feels you shouldn’t maximize return for a given level of risk.  Instead you should figure out what is the maximum level of return that the client can accept.

F-Squared believes that downside risk management has a disproportionate impact on clients, according to Present, so they factor it into their portfolios at a higher level.  Standard deviation is used to represent investment risk and maximum drawdown to represent the client’s perception of portfolio risk, he said.

Murray disagrees with Jones and believes there is some value in modern portfolio theory but that it is just one data point.  It’s not enough to rely on by itself.  At Russell, they know that different asset classes follow different pattens in the market so they use using different asset classes to offset each other in a portfolio by combining long and short term market processes, he stressed. Continue reading