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THE ART AND SCIENCE OF ASSET ALLOCATION
Asset allocation goes beyond the basic idea of spreading
risk by not putting all of one’s eggs in one basket. As
Harry Markowitz showed in his Nobel Prize winning work,
it is possible to combine several risky assets in a
portfolio and come up with less total risk than the
individual components. Because asset values change by
different amounts and in different directions, it can be
possible to add a risky asset to a low risk portfolio
and reduce the risk of the portfolio - in oversimplified
terms, when one asset goes down, another goes up. The
science of asset allocation is all about choosing the
best combination of assets. This science is not
finished, however, and is still being refined and
improved. The Art and Science of Asset Allocation looks
at the art of applying the current science, its
limitations, and the results of recent research and
development.ARTICLES
The Basics of Asset Allocation,
December 2006
Asset allocation is the process of dividing wealth among
different investments to achieve the highest possible
rate of return while keeping risk within acceptable
limits. It is based, in part, on the common sense risk
management notion that it’s better to not have all of
your eggs in one basket. It goes considerably beyond
this simple notion, however. It includes the science of
modern portfolio theory and the understanding that it’s
the risk of an entire portfolio that matters in
portfolio management and not the risk of individual
securities or asset classes.
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Article
Dealing with Uncertainty,
March 2007
Markowitz mean-variance optimization is not a finished
science. It has been challenged on several fronts and
refined by the development of more sophisticated
optimization techniques that better accommodate the
inherent uncertainty in capital market expectations. In
this installment of the Art and Science of Asset
Allocation, the Advisor reviews a new concept of
portfolio efficiency, resampled efficiency, and explains
how it is a significant step forward in the science of
asset allocation and portfolio optimization.
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Article
The Limitations of History,
August 2007
If we are going to use history as the basis for future
expectations, is it appropriate to include data from the
time of the Great Depression in our historical
statistics? Some would argue that it is not. In The
Limitations of History, the Advisor argues that averages
must span long periods to be reliable statistics and
that, in general, longer-term averages are better than
shorter-term averages. Although the circumstances of the
Great Depression appear highly remote, extreme outcomes
are more common in capital market returns than we think.
Nevertheless, the critics of long-term statistics might
be right, but not for the reasons they cite.
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Article
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