'Past
investment performance is not an indicator of future investment results' is
a required, responsible, and absolutely true investing footnote; an investing
fact that anyone who has spent more than a nanosecond in the financial markets
would or should know, and an investing law designed to protect the investing naive,
innocent, and unsuspecting. Then
why would one blindly place his/her trust in the present and his/her hope for
the future in a mythical investing science - Modern Portfolio Theory and all of
its illegitimate relatives such as Monte Carlo Analysis, Efficient Frontier Analysis,
Beta, Brinson's Asset Allocation, Pie Charts, and a distant relative, Technical
Analysis (worth a glance) - that relies solely on past performance investment
data to feed hypothetical and contrived investing algorithms in a misguided effort
to predict future investment results? All
are just other ways to record and to illustrate investment history without valid
analytical, interpretive, deductive, predictive, or directional investment value. Yet
knowing that past performance is not an indicator of future investment results,
most investment advisors, money managers, and individual investors build their
investment advising and investing performance cases by defiantly applying flawed
past performance investing concepts - such as Modern Portfolio Theory, Monte Carlo
Analysis, Efficient Frontier Analysis, Alpha, Beta, Standard Deviation, VaR, Sharpe
Ratio, and Investing Technical Analysis:
Because little or no investing judgment or skill is required; just scan, sort,
pick, retrieve, view, print, present, and hope that the investing past will somehow
become the investing future.
By stubbornly using investing software tools that base all calculations, conclusions,
and projections on past investment performance data; performance more by chance
than by design.
If
this investing nonsense were valid, there would be no need for investing analytics,
forecasting, or guidance of any kind - research, analysis, opinion, advisors -
and one would simply select investments based on past performance without regard
to suitability, quality, structure, or risk. Explained
another way, a thermometer measures temperature in degrees as the weather changes.
A
thermometer is a recording device not a forecasting one and, therefore, it
cannot be used to predict future temperature levels. Standard
Deviation, Efficient Frontier, Beta, VaR, and Sharpe Ratio are much like a thermometer;
merely means to measure past (contrived) relative investment performances between
investment variables and neither the cause of nor the predictor of either. Furthermore,
if a thermometer also happened to store prior temperature readings on a daily
basis, you certainly would not retrieve that information and use it to predict
tomorrow's or next week's temperature readings. As
one would have to analyze the weather-changing causal variables that affect weather,
such as humidity and barometric pressure, to predict future temperature levels. The
same holds true for historical Standard Deviation, Efficient Frontier, Beta, VaR,
and Sharpe Ratio readings as a basis for predicting the investing future. Future
investment values and associated investment/investing risks can only be meaningfully
understood and predicted based on one's correct understanding and interpretation
of the fundamental performance changing, causal investment performance variables
that actually affect an equity's behavior. Keep
in mind, there is no theory - modern or otherwise - that can be ordained, no computer
that can be programmed, no software that can be designed, no investing tool that
can be 'imagineered,' no technical analysis voodoo methodology that can be contrived,
and no equation that can be divined to quantify, evaluate, and predict the primary
forces that drive the sublime chaos of the financial markets and investment prices;
human consensus, mood, and behavior; intelligent and not, knowledgeable and not,
reasoned and not, rational and not, and logical and not. |
Brinson's Asset Allocation Modern
Portfolio Theory and Brinson's Asset Allocation came into being when the "boyz
'n the 'hood" at your local institutions of higher learning did a little back
testing of the past performance of investment sectors. They
added the investment term "Asset Allocation" to be on a level with their credentials/studies/writings
and then, oh yes, produced pounds and pounds of equations. They
came to the profound conclusion about asset allocation that, in part, is obvious
to begin with: Brinson
et al. describe the investment process used to manage a portfolio as a hierarchy
of three decisions taken one after the other:
- Investment Policy
- Decision 1:
Choice of asset classes in which to invest.
- Decision
2: Choice of normal asset class weights that remain unchanged over time.
- The
weights are often determined by an optimization procedure designed to generate
an expected risk (variance) and return appropriate to the circumstances of the
particular investor. (Choice of asset mix.)
- Investment
Strategy
-
Decision 3: Security selection and market timing.
- Choice
of individual securities within each asset class, and adjusting the asset class
weights from their normal values on a short-term basis.
The conclusion: "The
contribution of investment policy is the overwhelmingly dominant contributor to
total return, and dwarfs the contribution of investment strategy."
Hmmmmm,
let me see if I understand....... Invest
in the right asset classes and the right investment sectors with the right mix
and with the right amount of investment capital and investors will do better than
if they invest in the wrong asset classes and the wrong investment sectors with
the wrong mix and with the wrong amount of investment capital? What
a concept! It
was further concluded that the selection of individual investments and investment
timing, an "investment strategy," had little to do with investment performance. Hmmmmm,
let me see if I understand.......
Whether you select the right investment at the wrong time, the wrong investment
at the wrong time, the right investment at the right time, or the wrong investment
at the right time, your decision will have little to do with determining investment
performance? They
received a Nobel Prize for this? Felony
stupid! Gary
Brinson and associates studied a group of pension fund managers and used their
results to generalize about investing, investment performance, investors, and
investment advisors. They
limited the scope and the breadth of their study to a group of pension fund managers
and, therefore, limited the possible conclusions down to one:
- They concluded, you will
never guess what they concluded, that over 80% of the differences in performance,
"the variations in total returns," among investment professionals could
be explained simply by classifying and ranking the pension fund managers, used
in their very "limited and selected study," according to how much of
their assets were placed in three broad asset classes; stocks, bonds, and cash.
-
The best mix of the three asset classes had the best results.
Do
you mean to tell me that the top money manager could pick the best mix of the
three broad assets classes by ranking their performances correctly and by weighting
the capital to be applied to each of the broad asset classes correctly based on
their projected performance rankings and then could choose a broad range of the
worst underlying investments at the worst time for each broad asset class and
that that money manager would have the best investing and investment performance
results simply because he/she picked the best mix of the three broad asset classes?
Worst
of all, the conclusions of Brinson's Asset Allocation Study are being misused
daily by the new and naïve minions of Brinson Asset Allocation believers
who, by misquoting Brinson by omitting the words, "the variation in,"
in the phrase, "explaining on average 93.6% of the variation in total
plan return...," have been able to further compromise the initial Brinson
Study and its general conclusion to create a more specific and vastly more convenient,
though completely untrue, Brinson's Asset Allocation conclusion; such as, "explaining
on average 93.6% of total plan returns" to conclude that asset allocation
(of asset classes) alone determines 93.6% of investment returns.
- Not correct, it is only
the variations in, the differences of performances between the money managers
used in the study that are explained by the study.
- And,
the actual Brinson conclusion is also absurd because they conclude that investment
selection and investment timing are not factors in the investment performance
equation.
Other
poorly translated, and incorrect, conclusions of Brinson's Asset Allocation theory
include the following: - "The
results of this study have had an overwhelming impact on the way investment portfolios
are constructed, managed, and compared."
- "You
would have beaten over 80% of all professional money managers if, over the past
ten and twenty years, you held one quarter each of indexes of large US stocks,
small US stocks, foreign stocks and high quality US bonds."
- "The
amazing truth is that over a long enough time period almost any reasonably balanced
index strategy will best the overwhelming majority of 'professional' managers."
Well,
without getting into the arguments of the validity of Brinson's Asset Allocation
theory, no, let's get into it. Because
of the fiduciary capacity of pension fund managers to meet their investing responsibilities,
this class of money managers did what most money managers under the same investing
conditions would have done, they were more conservative and more on the investing
defensive; don't need anybody going off on his or her own investing tangent trying
to be a hero: They
used their best investing judgment to rank the future performance possibilities
of the three investment classes. They
allocated capital accordingly. They
diversified into many different investments within each of the broad asset classes. As
there was very broad investment diversification within asset classes so as not
to be too aggressive with very conservative capital, stock selection, the art,
the expertise, and the skill of picking the best, the most timely investments
within broad asset classes, would have to be diminished in importance
as the number of investments in each investment sector within each broad asset
class were increased. The
more the diversification to reduce investment risk, the closer to investing in
all of the investments in an asset class, the closer to index investing, the less
"stock picking and investment timing" there can be and the
less important stock selection and market timing, therefore, will be. Since
the investment styles essentially had to be/were the same, and the broad selection
of investments within asset classes were similar, the only way to grade performance
would be to see who did the best in picking the distribution of capital to the
three asset classes. The
conclusions of Brinson's Asset Allocation would have to be that 80% (why
not 100%) of the variation in plan performance was explained by how much capital
was invested in the asset classes and that investment performance has little to
do with stock selection and investment timing because the structure of Brinson's
Asset Allocation left out all of the other investment variables that do affect
investing and investment performance results! If
a broader universe of investment managers, investors, and investment styles had
been used, the conclusions would have been that there are many factors that explain
both variations in total investment returns and actual investment performance. Granted,
stock picking, investment timing pension fund managers used in the study may not
have done well (a possible reflection of the skill levels of the fund managers
or the difficulty of stock picking and investment timing) but that does not remotely
translate into the conclusion that stock selection and investment timing have
little impact on investment performance and into the suggestion that future investors
need not place too much emphasis on investment selection and investment timing
to improve investment performance. The
theory of Brinson's Asset Allocation is further flawed: - The
samples used in the study were limited to but one class of investment advisor;
pension fund managers.
- Choice
of normal (whatever 'normal' means?) asset class weights remain unchanged
over time.
- "The
weights are often determined by an optimization procedure."
- Optimization
uses investment history; therefore, it is worthless for the investment future.
- Different
investment styles for different types of investors with different investment goals,
different investment risk tolerances, different investment time horizons, and
different investment performance results were excluded from the study.
- As
for the lowly stock pickers and market timers, "Stock
pickers and market timers were not the leaders with regard to investment performance."
- They
could not possibly be the leaders based on the terms and conditions of the study!
- The
small group of pension fund managers that emphasized stock picking and market
timing, poorly represented, never had a chance.
- The
"how much" of the... "best mix of the three asset classes" as
selected and weighted by the best money managers was "determined by who used
the best timing to select the best mix of the three asset classes, the very same
factors that would be used by those selecting and timing investments."
- Timing
for asset classes and no timing for those selecting investments?
- Timing,
I thought that was out!
Any
statement that reaches a conclusion that investment selection and investment timing
have little effect on investment performance is ludicrous. The
theory of Brinson's Asset Allocation is absurd: - Think
about this, the theory of Brinson's Asset Allocation states that investment selection
and the timing of buying those investments has little to do with investment results.
- All
investing is about picking, selecting, timing, and weighting of asset classes,
investment sectors, investment categories, and individual investments.
- The
one who has the best mix of all will always do the best.
- Allocate,
but what you invest in to allocate is not all that important?
- That
conclusion is truly absurd.
-
Why not go to corporations that are looking for acquisitions and advise them not
to pay too much attention to investment selection and investment timing.
- Just
allocate into broad asset classes and give no consideration to the selection and
timing of the underlying investments in each broad asset class!
- Try
telling the guy who held onto his General Motors from 2002 to 2006 that instead
of selling General Motors and investing in Boeing in 2002 that investment selection
has little to do with investment performance.
- General
Motors went generally southward from $70.00 in 2002 and to $20.00 in 2006....(to
$3.00 in 2008.)
- Boeing
went generally northward from $30.00 in 2002 to $75.00 in 2006.
- Try
telling this same General Motors guy that he need not be concerned with investment
timing.
- With
some investing skill, a little investment luck, and without much added investment
risk, he could have owned over three times as many shares of General Motors with
the same amount of initial capital had he sold GM in 2002, waited a few years,
and then bought GM back in 2006...(and hopefully sold in 2007.)
- Try
telling Mr. GM that if he went a step further and had been lucky enough, smart
enough to sell some or all of his GM in 2002 and purchased Boeing in 2002 that
neither investment selection nor investment timing have much to do with investment
performance.
- I
know, I know, I know! The examples are the extreme and the rare exceptions
of investment selection and timing perfection, but the conclusion is not; investment
selection and timing are very important and they both are part of the investment
performance equation.
Though
the allocation of capital is an important starting point for designing and constructing
investment portfolios, Brinson's Asset Allocation is a mindless investing comfort
zone for those who are satisfied with being average and who do not choose to accept
either the challenge or the responsibility of knowing how to select investments
or time investing. Enough
of Brinson's Asset Allocation Theory Bashing! Rather
than assign an excessive valuation percentage to any one contributor of investment
performance, 100% of investment performance can be explained by the proper heed
and use of all of the following portfolio management considerations listed below. The
contributors to investment performance are listed in no particular order
of importance, that is, until the final four; with grave reservation, they
are most reluctantly included. They
were included so as not to be guilty of doing what the fathers of the theory of
Brinson's Asset Allocation did to manufacture their investment conclusions by
arbitrarily omitting some of the known variables that are also "overwhelmingly
dominant contributors to total investment returns."
| Contributors
To Investment Performance: | Not Worthy:
-
Efficient Frontier -
Beta & Alpha -
Monte Carlo -
Past Performance | .
100% of the lack
of investment performance can be explained by ignoring these portfolio management
considerations, by reversing their order, and/or by overemphasizing one at the
exclusion of the others. I
would have been happier and supported Brinson's Asset Allocation Theory with a
burst of unbridled enthusiasm had it concluded that Modern Portfolio Theory,
Efficient Frontier, Beta & Alpha, Monte Carlo, and Past Performance are the
overwhelmingly dominant non-contributors that do not impact total investment
returns and, in fact, these concepts had no value in accounting for 91.5% of total
returns. Visit:
THE
IMPORTANCE OF ASSET ALLOCATION
by John Nuttall (for a more scholarly presentation) |