Comments on: The lunch may be free, but how much is it worth?

By: Are asset allocation models broken? Abnormal Returns

Are asset allocation models broken? Abnormal Returns — Fri, 10 Jul 2009 18:36:47 +0000

[...] a hit and investors pulled back on risky assets of any kind the flaws of this approach stood out. Seemingly unrelated assets now traded in near lockstep. David Merkel at the Aleph Blog notes that investors of all stripes were invested in far riskier [...]

By: Twofish

Twofish — Fri, 10 Jul 2009 15:02:31 +0000

Diversification is not a free lunch. Your expected return goes up, but your maximum return goes down. If your bonus is based on maximum returns, then you don’t want to diversify.

Also real diversification is a *LOT* harder than it sounds. Globalization and the internet have made diversification even harder because now everything is connected to everything else so that when one thing falls, everything falls.

What’s really funny is if when you hear a thousand people talking about diversification, and then they all end up diversifying to the same thing.

By: q

Fri, 10 Jul 2009 11:57:22 +0000

another interesting article.

http://alephblog.com/2009/07/10/toward-a-new-concept-of-asset-allocation/comment-page-1/#comment-22112

By: MarcoPolo

MarcoPolo — Fri, 10 Jul 2009 10:33:50 +0000

Mark, (using my spellchecker) transmission mechanism? I thought you were going to tell me that it was about base money not money supply.

Frankly, I’ve been in the camp with those others. Intuitively, I feel we use the term deflation to mean contraction. Investing for the long term (what is thought of as dumb money) requires understanding this macro – though I suspect I don’t. There is already too much money in the S&P 500, etc. Diversification among those already oversold traditional instruments is my own idea of dumb money. Real diversification is to break the bonds of feudal industrialism and to own/control once again the means of production.

By: Aditya

Aditya — Fri, 10 Jul 2009 08:02:29 +0000

Great article Mark. I completely agree with you. I think USD and Crude Oil moves have been a lead indicator or trend setters for a large section of equity and commodity markets due to changes in risk aversion. How do you keep track of correlations and which financial indicators do you put an emphasis on?

By: Rien Huizer

Rien Huizer — Fri, 10 Jul 2009 07:44:53 +0000

Mark,

Pse tell us more about investing. It would be nice to learn how we can get rich (which is Glorious of course).

Re diversification: portfolio theory does not work in the real world because we do not know with what data to feed the models. Past data work only if we are lucky. So we are just making gambling for someone else’s account a little less transparent and the gambling agent less suable.

If you have a theory that justifies a given set of covariances and have proof that that theory is valid during a given segment of the future, then it would make sense to see if an optimal portfolio according to that theory and data would beat the risk free rate over that segment of the future. If it did, it would be interesting to understand what market failure was responsible for that anomaly, harvest it and tell no one else…

By: Rien Huizer

Rien Huizer — Fri, 10 Jul 2009 07:26:18 +0000

The only optimal degree of diversification is ex post..

By: Mark Dow

Mark Dow — Fri, 10 Jul 2009 00:34:11 +0000

MarcoPolo – I took a look at the article you referenced. You’re right: It doesn’t jibe with what I wrote at all.

Their analysis of the modern global transmission mechanism is precisely why I wanted to address this topic. As I said, stories that are simple and intuitively appealing are hard to shoot down–irrespective of how untrue they may be.

I think the article reflects an anachronistic and superficial view of monetary economics. But, honest men can differ…

By: mark folsom

mark folsom — Thu, 09 Jul 2009 23:59:19 +0000

Bob Prechter wrote an article in Barrons 5 years ago describing his “all the same market” theory and your post is a little late but supports his theory. Basically all markets… commodities, bonds, stocks are just responding to the global ebb and flow of liquidity. Massive deflation is working its way through the system and the markets will one day all come down together again just like the end of 2008. Diversification is another media/ Wall Street fraud in this environment. Look at the dismal performance of junk bonds during the bull market of the nineties. Now they track the stock indexes.

By: MarcoPolo

MarcoPolo — Thu, 09 Jul 2009 22:52:48 +0000

Mark, I'm still on the last chapeter struggling to understand. THIS from QB Partners via The Big Picture doesn't seem to jive with what you were telling us a couple of days ago. Care to comment?