Ashvin Chhabra is the CIO of the Institute of Advanced Study at Princeton, where he manages the endowment. His presentation is A Goal-Based Risk Allocation Framework for Unstable Markets. the focus is on individual investors.
My session notes follow. As always, these are at-the-time notes. I make no guaranty as to their accuracy or completeness.
- Illusions are prevalent in how we look at markets; we simply have different perspectives (buyer and seller have access to the same information).
- Different perspectives lead to unstable prices.
- A bubble in a market based upon the world’s reserve currency will have global impacts.
- Art — what’s “value” (not “replacement cost,” surely).
- Market prices are based upon both economic and social interactions, leading to instability; during to periods of instability, devastating impacts are possible/likely (the flaw of averages).
- Three dimensions of risk (more here and here) — personal (don’t jeopardize lifestyle), market (maintain lifestyle) and aspirational (enhance lifestyle).
- Asset allocation a form of risk allocation.
- We like to buy both insurance and lottery tickets (behavioral finance Kahneman and Tversky) — fear and greed; we tend to pay too much for both.
- Deviations from “rationality” (e.g., insurance and lottery tickets) are not always mistakes — can be based upon good reasons.
- Mandelbrot — markets are not mildly random, but wildly random.
- Must take “fat tails” very seriously (following Taleb).
- Real estate performs historically at about the rate of inflation (remember to include cost of upkeep); similar to gold.
- Long-term predictions re markets are a fool’s game.
- Normal distributions overestimate the middle; low probability events can have huge impacts.
- If it were possible form a cost standpoint, one would want an index plus a put and a call (to cover all the possibilities).
- It’s very difficult to make a dramatic move across wealth classes via diversified asset allocation.
- Aggressive (v. growth and income) asset allocation, on average, can only move 40th percentile in wealth to 60th percentile over 100+ years (chasing returns makes no sense).
- Wealth mobility via concentration and leverage (e.g., great new business, but note survivorship bias; real estate can work — natural leverage; hedge funds — 2+20: non-recourse leverage; inheritance).
- Re real estate, gold and AI: “personal risk” bucket — goal is protection (house, gold in small quantities); “market risk bucket (diversified AI); “aspirational risk” bucket (speculative gold investments).
- Kahneman — we aren’t irrational, we aren’t well-described by the rational agent model.
- Objective: begin with goals and then build toward those goals.
- Unfortunately, we have tended to do away with safety nets (e.g., pensions).
- There is no low risk/high return bucket — if you think you have one, get rid of it because you don’t understand it (unless you’re Warren Buffett).
- The slides will be made available after the conference.
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“There is no low risk/high return bucket”. I have to disagree. I think Ashvin Chhabra is using some statistical measure of risk, such as volatility. There is little or no correlation between risk (as measured by volatility) and return, in other words that there is a risk premium return attached to more volatile stocks. On the other hand, if you understand risk as permanently losing money, then there absolutely are investments out there that are low risk, and yet can provide a high return. The return is a function of your entry price — in other words, you have bought something for substantially less than its intrinsic value, and you will earn a higher than market-average return if and when the market recognizes the intrinsic value. This is the essence of value investment. You don’t have to be Warren Buffet, or even extraordinary skill, to do it. Just the willingness to learn, time and patience. Heck, one can mechanically apply David Greenblatt’s “Magic Formula”, which is really just a value screen, and achieve a low risk/high return outcome over the long run under a portfolio’s theorist’s criteria.