There’s nothing like a crisis to make an industry question its fundamental beliefs, and poor old Harry Markowitz has certainly been in the firing line since everybody’s asset-allocated, ‘diversified’ portfolios all crashed together in 2008/9. Does his modern portfolio theory still stack up? What role will alternative assets play in any, ahem, alternative to it? These questions are sure to be fiercely debated at September 8’s third annual Absolute Returns Conference, produced by Conexus Financial (publisher of this magazine). Diversification ain’t diversification when everybody’s doing it, it seems, and as KRISTEN PAECH reports overleaf, some stakeholders are now calling for a more ‘back to basics’ approach, even dragging the old ‘balanced vs specialist’ debate out of the mothballs. Elsewhere in this Absolute Returns Conference primer, SIMON MUMME reports on the managers who try and make beta better – the activist hedge funds – and finds out why they’ve struggled for a toe-hold in Australia. Meanwhile, GREG BRIGHT investigates a hybrid between private equity and credit which promises the best of both worlds – mezzanine debt. Let the alternative ideas flow…
Death knell for asset allocation, or a new dawn?
When most correlations went to ‘one’ during the financial crisis, investors were left questioning whether the established principles of asset allocation and diversification still held up. KRISTEN PAECH investigates whether we’re witnessing the end of ‘asset allocation’ – with the multiple managers and ‘buckets’ the term implies – or a return to the simpler days of portfolio construction, and the role that absolute return-seeking alternatives will play in either scenario. Warren Buffet once described diversification as a protection against ignorance. “Wide diversification is only required when investors do not understand what they are doing,” he said. But during the financial crisis, asset class diversification failed to protect even the savviest of investors, with many of the world’s most sophisticated investors suffering the wrath of the global financial market meltdown. Brinson’s landmark 1986 paper “Determinants of Portfolio Performance”, famously argued that asset allocation drives more than 90 per cent of return variation, with stock selection accounting for less than 10 per cent.
However the high correlation displayed between most asset classes during the crisis has led many funds to question whether the “policy portfolio” or long-term strategic asset allocation is dead. As the argument goes, you can’t set your investment strategy based on longterm assumptions; you have to be more tuned in to current market conditions. In a recent paper by Citi Global Markets titled “Multi-Asset Strategy for Australian Investors”, Citi says globalisation has increased the interrelation between asset markets, products and regions. “At the same time, the accessibility of all investors to new regions and asset classes has increased markedly,” the paper notes. The classic GFC case of how diversificiation strategies can break down was outlined recently by Pimco’s head of analytics, Vineer Bhansali, and relayed by Felix Salmon’s ‘Market Movers’ blog. In a note, Bhansali reminded investors of how commodity prices enjoyed an historic rally in early 2008, as stocks and bonds struggled.