CFA Conference: Christopher Ailman

 Christopher Ailman is the CIO of CalSTRS, at $120 billion, second-largest DB fund in the nation and the manager of my wife’s pension (she is a school teacher in San Diego where we live). His presentation is entitled Allocating Risk Capital in a Low Interest Rate Environment.

My session notes follow.  As always, these are at-the-time notes.  I make no guaranty as to their accuracy or completeness.

  • He’s a big fan of Jimmy Buffett — a committed Parrothead.
  • Teaching is more of a lifestyle than a job.
  • Teachers live longer than any other profession and they represent 70% women — the demographics are tough for the plan.
  • Fed announcement 1/23 — low rates on tap for at least a while (321 months and counting).
  • Chart — 20-year decline of UST 10-year notes (and huge bond returns).
  • Lost decade?  Even during secular bear markets, significant cyclical bull markets (up to 25+% — cf., Japan).
  • During secular bear markets — how to trade to take advantage of the cyclical bull markets?
  • “‘Buy and hold’ doesn’t work in this environment.  We need to be nimble” (even though — as a “cruise ship” it’s tough to be nimble).
  • Being nimble, tactical and active is akin to market-timing, but that isn’t likely to work; thus — what to do?
  • DB plans are under attack — expect it to continue.
  • Lack of DB plans in the private sector has led to “pension envy” toward the public sector.
  • Debate over pension funding and management should be done by CFAs, not politicians.
  • The cost of retirement has gone up and is going up (20% savings rate probably required all-in).
  • DB plan provides better risk-return envelop than DC (economies of scale and asset allocation).
  • There is a value to funding retirement despite the cost.
  • The true replacement rate likely to be closer to 90% than the traditional 75% (Georgia State Replacement Ratio Study).
  • Problem with Gen X/Y who may be spooked away from investing in stocks.
  • Portfolio construction tougher than ever; fat tails are 4% of outcomes; a crisis every 5-7 years (we want a more stable worth but aren’t likely to get it).
  • Cf. PIMCO study of typical endowment return — 4% fat tails.
  • As rates fall, FI portfolio duration tends to be extended to get yield — rising rates will have a very serious impact.
  • What does it mean for a portfolio if bonds have a zero expected return, perhaps for a decade or more?
  • Strategies: dividends and high-yielding ETFs; MLPs; sell equity vol and skew; corporate credit w/strong balance sheets; provide monetizing consistent, mature drug royalty streams; incremental income from existing asset allocation (from Morgan Stanley pension/endowment/foundation report).
  • Strategies from Ailman’s staff: covered calls and index calls; infrastructure (brown field/high cash flow); leasing (RE/aircraft/equipment); senior secured loans (Europe and U.S.); long-tail revenue streams (royalties); distressed debt.
  • As always, it’s all about price.
  • Approach: stay nimble; non-traditional asset classes; complex and illiquid investments, perhaps with a limited window.
  • Note that correlations are non-stationary (diversification not enough) and that investors need more risk management tools.
  • Huge political risk post-election: capital gain increase?
  • Risk isn’t discreet — it blurs across the portfolio.
  • Risk factors for Ailman (that blur): investment governance — regulation and taxation; leverage; liquidity; inflation; interest rates; global economic growth.
  • So what? building portfolios more complex than ever; “low return” depends upon time horizon; income rules; costs of retirement going up for all’ black swans and fat tails happen.
  • Re discounting liabilities: for Ailman, set by Board; Ailman argues that there is no one simple answer; multiple answers — can’t know costs until we “get there”; consistent contributions necessary.
  • We can’t keep kicking the can down the road; political issues are tough.
  • Active/passive — Ailman has lots of passive in his portfolio (market cap — even though it forces him to buy high and sell low to a point, but we need a measurement tool); looking at tilting via indexes and equal weighted indexes.
  • Re fundamental indexes — Ailman likes the idea (DFA).
  • Markets are highly efficient, but he still sees value in active management despite periods of underperformance.
  • Looking to hedge (dynamically) more and more, especially due to the speed of information and globalization (correlation harder to achieve).
  • Public fund and individuals not as able to maintain illiquid investments to the extent that endowments can.
  • Ailman has been underweight most of this year but are now neutral (low P/E and decent earnings but lots of “overhang” — such as Europe and deficits); portfolio has home-country bias; market more differentiated and fragmented than normal by a lot.
  • Be nimble (emphasized yet again).

CFA Conference: Eugene Fama

Eugene Fama is Robert R. McCormick Distinguished Service Professor of Finance at the University of Chicago Booth School of Business.  As James Montier noted Sunday evening, he may be the last person alive who accepts the efficient markets hypothesis. Even so, through his research he has brought an empirical and scientific rigor to the field of investment management, transforming the way finance is viewed and conducted. His presentation will focus upon his perspectives on financial research.

My session notes follow.  As always, these are at-the-time notes.  I make no guaranty as to their accuracy or completeness.

  • Went from being a jock to the University of Chicago — “I knew I didn’t want to work for a living.”
  • He works hard, but as an academic, it can be on his schedule.
  • Why market efficiency and equilibrium are so important — the basis of capitalism (markets work).
  • Efficiency and equilibrium jointly est each other; “the two can never really be separated.”
  • “I was the first computer user” from the UC Economics Department (along with a Physics student).
  • It’s important to “think differently” about something you’re working on — colleagues who push or influence you to do that are invaluable.
  • Lessons from financial crisis — he tends to think it was an economic crisis that caused a financial disaster (and not vice versa); huge recession was the key (a pretty contrarian view).
  • Per Fama, the sub-prime crisis (a U.S. phenomenon pretty much) wasn’t big enough to bring us down (Seawright: what about fragility and complexity?).
  • “Too big to fail” is a huge problem and a major moral hazard; Dodd Frank cures none of this.
  • He doesn’t expect the Volcker Rule to accomplish much either (and not optimistic about curbing insider trading either).
  • Pension crisis — claimed liabilities are about a third of what they really are — it’s basic finance (not accounting); a period (or periods) of bad markets are essentially inevitable; per Fischer, finance DB plans with debt; some big state is likely to go bust due to pension obligations.
  • Active management is a zero-sum game (net alpha is zero); some managers take alpha from others.
  • A “good pick” is always balanced by a “bad pick.”
  • After costs, only 3% of active managers are good enough to cover their costs (barely) — and they’re probably lucky.
  • “Five or ten years of returns are basically garbage — noise. You need at least 35 years of data to be useful.”
  • Lower discount rate means expected returns have gone down (about 4% real).
  • Working on a paper that claims the Fed can’t really do anything to impact real rates. “It all comes down to saving and investing. There’s a glut of savings” (to make rates so low).
  • Three-factor model (CAPM supporter prior) — what happened? CAPM had trouble explaining small cap. dividend stocks, etc.; in 1992 F&F put this all together (nothing new) and said CAPM “dead in the water.”
  • 1993: developed 3-factor model.  He sees value and size as risk factors that can’t be diversified away (even though we can’t explain why); price contains information not explained by market beta.
  • Value outperforms growth; low beta outperforms; small not-so-clear.
  • Growth stocks are simply expensive (high performing and highly priced).
  • There are a plethora of value funds now (some of which don’t even know what that means), but “the market” (by definition) can’t lean one way or the other.
  • For some it’s a matter of taste — “I like growth stocks and will take a lower expected return.”
  • Momentum (a potential 4th factor) — the “biggest potential embarrassment to market efficiency”; what’s momentum today likely won’t be in three months.
  • Behavioral finance valuable in the particular, but little more than ex post story-telling overall (no testable hypotheses).
  • Behavioral story ” “People are born stupid and stay stupid” and professionals are prone to the same problems to the same extent.
  • If everyone leapt on value, the premium would disappear (obviously).
  • Obama Administration believes in “command and control” (e.g., regulation), but not incentives; most economists think that’s a problem, but not necessarily politicians.
  • Excess-return low vol stocks are really low beta stocks — well-known for 50 years; has now come back into vogue (original CAPM assumed people could borrow at the risk-free rate).
  • If we all exist passively (“I’m asked this question three times a day”): won’t happen.
  • Bridgewater “risk parity” investing: “stupid.”
  • Central bank balance sheet expansion — “The Fed has basically made itself powerless”; they are simply issuing bonds to buy bonds.
  • Re debt, the question is how much to sacrifice the future for the present.
  • We can inflate our way out of the crisis, but we might take ourselves down in the process via hyper-inflation.
  • Simple fix: balance budget using 2007 expenditures — what have we added since then that’s so important?
  • Active managers and advisors that use such funds are wasting their time and ripping off clients.
  • The advantage that active management can add (assuming any can be added) is only about 1% or so — why take the risk required to accomplish so little?
  • Small v. large: small premium seems to be decreasing, but prior measurement of “small” were really measuring value (no evidence of change).
  • Value — expect long periods of underperformance.
  • Value has now been verified world-wide (in every market — even bigger overseas), but no size premium.
  • Fundamental fun of academics — you don’t know what you’re going to discover next week or next year.

CFA Conference: M. Barton Waring

M. Barton Waring is former global chief investment officer for investment strategy and policy at Barclays Global Investors. He serves on the editorial boards of the Financial Analysts Journal, the Journal of Portfolio Management, and the Journal of Investing. Mr. Waring recent book is Pension Finance: Putting the Risks and Costs of Defined Benefit Plans Back under Your Control, upon which this presentation is based.

My session notes follow.  As always, these are at-the-time notes.  I make no guaranty as to their accuracy or completeness.

  • Pension finance: where actuarial science meets economics.
  • Conventional pension actuarial accounting (book value) has a high degree of distortion (market value accounting is required).
  • Many potential accrual methods, and none conveys anything like “real” information.
  • Central question: What is the right discount rate?
  • The accounting will always follow the economics.
  • If the economics are managed, the actuarial and accounting versions will follow.
  • How big is contribution volatility?
  • Only 3 liabilities are of economic interest: full economic liability; present value of future benefit payments; and the “benefit security liability.”
  • The idea: to amortize the unpaid portion of a debt through some form of payment function.
  • Many payment functions in use for actuarial normal cost.
  • Pension expense and contributions should equate economically.
  • Why discount at the expected return on assets?
  • Risk: Investors don’t “get” expected returns even though they are long-term investors (risk doesn’t go down over time — it increases).
  • Risk to wealth increases over time (a “bad” result is more likely).
  • You can’t leave pension results to “luck.”
  • That means higher contributions earlier (always lower later).
  • Using the “risk-free” rate nearly eliminates “surprises.”
  • Policy problem: who will pay the shortfall (overdue contributions)?
  • Discounting with the expected return on assets isn’t cheaper — it sets up a slow motion bankruptcy.
  • See Bill Sharpe video — The State Pension Actuary.


  • Pensions need to use actual realized returns.
  • Pensions are the only entities that do things differently.
  • That long-term investors really get the expected return is a myth.
  • A single pension objective, properly specified, can control almost all pension risk (other than demographic risks).
  • In sum, we need tough love to save underfunded plans (“good” benefits worth little ig the pension defaults).
  • In other words, if you price benefits at $.50 on the dollar, you aren’t going to have secure benefits.
  • The temptations to delay and avoid are extraordinary.
  • Rising rates would benefit pension plans.
  • It’s simple: if you don’t get the “expected return” over a significant period of time, you’re in big trouble.
  • The situation is dire — it’s late in the game; the problem needs to be fixed.

CFA Conference: Daniel Kahneman

Daniel Kahneman is Professor Emeritas of the Woodrow Wilson School at Princeton and a Nobel laureate in Economics for his work on behavioral economics.  His most recent book is the terrific Thinking Fast and Slow.  His presentation is entitled Psychology for Behavioral Finance.

My session notes follow.  As always, these are at-the-time notes.  I make no guaranty as to their accuracy or completeness.

  • Much of our thinking is “fast” — intuitive; System 1.
  • System 2 — “slow” thinking takes effort; it covers deliberation and monitoring System 1.
  • We are susceptible to priming (upper class British accent talking about large tattoos — we don’t see that as likely and are thus surprised).
  • After hearing about losing a wallet in a crowd, we are primed to hear “pickpocket.”
  • System 1 interprets the world, not always accurately (tells coherent stories while ignoring ambiguities and alternative explanations).
  • We tend to generate the “best” stories and to accept them — not necessarily governed by data.
  • Recommends Taleb’s The Black Swan.
  • When Saddam captured, stock market rallied (headline links rally to capture); when the market fell later in the day, that was also attributed to the capture.
  • System 1 a storyteller and an interpreter of what happens.
  • We think of ourselves in System 2 terms — effortful and deliberative.  Much of System 2 is covering up and interpreting System 1 thinking.
  • Confirmation bias — we stick with our stories and interpretations as long as we can, even unreasonably.
  • The lottery effect and risk aversion both impact us a lot; how these options are framed will greatly impact the results (framing in terms of “mortality rate” causes people not to get treatment while framing in terms of “survival rates” does).
  • If we have a good story, we are confident in its truth (and vice versa), regardless of te quality of evidence in support of it — explains a lot of market behavior.
  • Coherent stories quash doubts and support inherent overconfidence.
  • CFOs of Fortune 500 companies asked about forecasts re S&P 500 in terms of confidence; their forecasts were wildly in error, and they were supposed to be experts (“80% confident” was usually wrong — 67% of the time!); overconfident CFOs took more risks than others in professional lives — overconfidence causes damage.
  • System 1 consequence — intuitive rarely believes itself to be stumped (and we’ll then look like crazy to support it, no matter how off-the-wall if is).
  • On average, people know very little about the market and don’t predict market movements very well (even though we feel like we know a lot — we’d think we offered value even if/when we didn’t).
  • Insidious influence of System 1 inhibits successful analysis.
  • Not much we can do about these inherent biases!
  • knowing about the errors isn’t a recipe for avoiding them.
  • There are few things we can do.
  • When we note a risk — slow down.
  • Anchoring a big deal, especially in negotiations; so prepare to deal with it.
  • Organizations can do more in this area than individuals — quality control (examine systems and processes routinely).
  • Meetings — too much weight on those who talk first and talk loudest; helps to ask people to write down their views before the discussion starts — gets better results.
  • In organizations — optimism bias a real problem; ask group charged with a decision to write a diary of what went wrong (before the fact) with respect to a preferred approach; that helps decision-making.
  • Gossip is important — we talk about the failings of others; Kahneman wants to “educate” gossip — if we anticipate intelligent gossip, we’ll make better decisions.
  • Forecasting is poor, but the real problem is that people don’t know the boundaries of their expertise.
  • If we know our limits, we could be hopeful.
  • Overconfidence is essential;ly inevitable.
  • Scenario-thinking is problematic (creates stories and we are vulnerable to good stories).
  • We are also prone to superficial judgments too.
  • We can know are clients better; we need to make realistic assumptions about what they really want; “risk tolerance” isn’t the way most people think.
  • Most people want some mix of “sure thing” and “longshot.”
  • Watch out for clients most prone to regret (or keep them in safe assets).
  • We should all turn off CNBC and (per Thaler) shouldn’t look at portfolio returns even once a quarter — we react and we react wrongly,  buying high and selling low.
  • Discussions with clients are both joint discovery and education; we need clients to imagine their reactions in various scenarios.
  • We need reputations as truth-tellers, because some competitor will always tell a better and rosier story.
  • We need to condition people for the level of loss they can bear before (wrongly) changing course.
  • Neuroeconomics is exciting even though current methods are still primitive.
  • We don’t really want to put behavioral controls in place; being systematic helps — records, consistent processes, looking at pieces one-at-a-time and accountability (these things make us very nervous; afraid they will come back to bite us).
  • His work was important in economics because of what economists could do with it.

CFA Conference: Randall Kroszner

Randall Kroszner is the Norman B. Bobins Professor of Economics at the University of Chicago Booth School of Business.  He is also a former central banker and in this session he offers an insider’s perspective on international coordination of monetary policy.His presentation is entitled The Search for Stability: Regulation, Reform, and the Role of Monetary Policy. His latest book is available here.

My session notes follow.  As always, these are at-the-time notes.  I make no guaranty as to their accuracy or completeness.

  • We’re on the road toward dealing with monetary fragility, ut there’s a long way to go.
  • Why the fragility? Leverage, liquidity and interconnectedness.
  • Leverage: makes for a thin cushion against losses.
  • Liquidity: banks tend to borrow short and lend long — maturity and liquidity mismatch.
  • Interconnectedness: a change at one institution impacts (nearly) all others.
  • Knowing history is crucial in a crisis (history may not repeat, but it rhymes).
  • Kroszner isn’t a “natural” interventionist, but in the “eye of the storm,” it’s tough to believe that “the market will take care of itself” (especially under great time pressure).
  • Ben Bernanke has terrific powers of persuasion — to get consensus in the 2008 crisis.
  • The ECB is now mimicking the Fed circa 2008.
  •  TARP continues to make money for taxpayers but remains very unpopular (per survey data, torture is more popular!).
  • Incredible demands for short-term safe, liquid assets.
  • Can we get out of this without high inflation? In principle, yes.
  • Obviously, exit strategy is key; it will be very tricky; requires will and good timing.
  • Volcker was reviled in the 1980’s, but revered now; Kroszner thinks Bernanke will be similarly esteemed (if not yet).
  • Are we less fragile today? Similar issues and potential issues….
  • We shouldn’t put too many regulatory eggs in one basket (e.g., high core capital).
  • Banks holding lots of short-term government paper can be toxic (e.g., Greece), but not a likely problem in the U.S.; still we need an alternative.
  • Interconnectedness continues to increase (MF Global shows how little progress we have made via Dodd Frank).
  • Question re banks being active in proprietary trading — the goal is good (reduce risk). but definitional troubles and not a significant source of the crisis; will impede liquidity.
  • A clear regulatory line provides good incentive to move and remain right up to it.
  • Issue: unintended consequences of Fed balance sheet expansion: inflation (issue is will and knowledge to deal with risks); political pressure may undermine decision-making; moral hazard a concern and an issue, but are we willing to bear the cost of non-action.
  • In crisis, the Fed will generally want to increase demand for risky assets; without a reasonable growth path, it’s tough to get people to take such risks.
  • Can the Fed be more proactive? Dodd Frank expands the mandate, but puts the Fed into the “political crosshairs” (and the Fed isn’t elected — Greenspan criticized for hurting the market by claiming “irrational exuberance”).
  • Dodd Frank says the Fed should be looking for ways to help, but at risk to criticism for exceeding its mandate.
  • Kroszner doesn’t think the Volcker Rule is likely to help (see above); people naturally look to get around any imposed regulation.
  • Europe seems to be rejecting austerity (without it really being tried) and Krugman making similar arguments here — Kroszner would like emphasis on what the money is spent on as different investment have different “rates of return” and get money into people’s pockets more efficiently (not many projects were really “shovel ready”); we shouldn’t just spend money to spend money.
  • “We don’t want to end up looking like Spain or Italy in 5-10 years.”

CFA Conference: The Puzzling Popularity of Active Management

The University of Chicago Booth School of Business offered this presentation examining the continuing popularity of active management. The moderator is David Barclay, COO of the Center for Research in Security Prices. The presenter is Lubos Pastor, Charles P. McQuaid Professor of Finance at the University of Chicago Booth School of Business. He is also a Research Associate at the National Bureau of Economic Research and a Research Fellow at the Centre for Economic Policy and Research. The focus of the presentation is why active management remains so popular. Note this article on this subject (more here).

My session notes follow.  As always, these are at-the-time notes.  I make no guaranty as to their accuracy or completeness.

  • Are there too many active managers?
  • Well-known stats — in 2011, 79% of large cap funds underperformed the S&P 500; the average equity fund lost 3% and the average hedge fund lost 5% v. S&P 500 being up 2%.
  • Even Peter Lynch now recommends passive investment.
  • Passive management now represents about 15% of the market.
  • Why is the active market so large given performance (the assumption is that people are stupid).
  • Pastor: It makes sense that the active market would be large even if investors are all smart.
  • Alpha becomes more elusive as more money chases it (competition to find mispricings).
  • Think of active managers as police officers and mispricings as crime.
  • With disappointing returns, investors change expectations and reduce active investment (but the reduction is cushioned by decreasing returns to scale!).
  • As passive management grows, active alpha will improve.
  • Past underperformance doesn’t imply future underperformance (just that some money should be moved active to passive).
  • Passive management should therefore only grow slowly (active should decrease slowly).
  • Without active management, there would be a lot of mispricings; thus at least some active management is optimal.
  • On an industry-wide basis, some active management makes sense; but does that apply on a personal/individual level?
  • As index funds get bigger, it will be easier for active managers to outperform.
  • Money to be made at the expense of index funds (e.g., buying ahead of an index reconstitution).
  • Burk & Green (2004): as funds get larger, it will be harder to outperform; Pastor agrees.
  • Passive management may need to grow substantially before we begin to see significant impact of the sort Pastor predicts.
  • CRSP has and will have some new index possibilities combining academic research and industry practice with objective and transparent measures (see here).
  • These indexes focus on investability.
  • Fewer U.S. securities since 2000 (down about 1/3); thus breakpoints (e.g., small to mid-cap) defined by cumulative market cap.
  • Bands around the breakpoints to decrease trading costs for passive managers.
  • Mega-Cap (top 70%; 284 stocks today)); Large (top 70%; 646 stocks today); Mid-Cap (70-85%); Small Cap (85-98%); Micro Cap (98-100%).
  • CRSP indexes and migration — considered many approaches; weighed trade-off between turnover and style-purity.
  • CRSP introduced the concept of “packeting,” which cushions movement between adjacent indexes (to reduce transaction costs).
  • Multi-dimensional approach to value and growth.
  • CRSP — Re-engineered market-cap-based indexes, emphasizing cost efficiency.

CFA Conference: When Bloggers Meet

I had dinner with three bloggers you almost surely know and read already. If you don’t, you should. They are Tom Brakke (The Research Puzzle), Tadas Viskanta (Abnormal Returns) and Rick Ferri. They are all really smart, good guys and, best of all, have tremendous insights into the markets and our business.  It was an honor to be included with them.  We are pictured below (from left to right, Ferri, Brakke, Seawright and Viskanta).  Notice that Tadas’s new book, also titled Abnormal Returns (and you should read that too), is sitting on the table.

CFA Conference: Post Compendium

I have been live-blogging at the 65th CFA Institute Annual Conference here in Chicago.  I have been very gratified at the kind reception they have received. This post will act as a compendium of these posts so that you may find them in one convenient location. Links to this posts are provided below, with the most recent listed first.

CFA Conference: The Charley Ellis Challenge

Charles D, Ellis is a giant in our industry.  He is also a really smart guy — retired academic, founder of Greenwich Associates, former Investment Committee Chair of the Yale Endowment, and the author of fifteen books, including two of particular import.  These two books are Winning the Loser’s Game: Timeless Strategies for Successful Investing and The Elements of Investing (with Princeton’s Burton G. Malkiel). I met Charley today after he spoke here at the CFA Institute Conference.  That’s us above (the giant is on the left).  He was delightful.

Ellis sat for an interview with Consuelo Mack recently (it may be seen here).  As most of my audience will know, Ellis is a proponent of index investing for individuals.  Over the course of the interview, Ellis makes a number of interesting and provocative points, consistent with his books.

  • For individuals, everything begins with saving, and the earlier we start, the better (because “catching up is hard and keeps getting harder, the longer you wait”).
  • A few great investors (like Warren Buffett and David Swensen) can beat the market, but most don’t, which is why indexing is smart policy.
  • The competition among the hoards of industrious and talented investors to outperform is vigorous, effectively cancelling each other out.
  • A few investment firms have clients’ interests as central (such as the Capital Group, Wellington, T, Rowe Price, American Funds and Vanguard, but most are simply “commercial” and do not.
  • Investors should diversify as broadly and deeply as possible.
  • Commodities offer no economic productivity, making investment in them entirely speculative and to be avoided generally.
  • A key to investing is simply to avoid mistakes, like panic selling and greedy buying (but doing so isn’t simple).
  • Investors need accountability to someone who knows and cares about them.
  • Individual investors need to “stabilize” their portfolios as they get older, usually by owning more high quality bonds.

The interview is well worth your careful attention.  In essence, Charley is making the case for careful asset allocation using low-cost index funds with regular re-balancing and adjustments as needed to keep the portfolio in line with one’s risk tolerance.  This carefully articulated viewpoint leads to my statement of what I call “the Charley Ellis Challenge” — to the extent that you do not agree with or follow his advice, why don’t you and upon what evidence do you rely for not doing so?


CFA Conference: Thomas Idzorek

Thomas Idzorek is the Global CIO of the Institute of Morningstar. His presentation is The Impact of Skewness and Fat Tails on the Asset Allocation Decision (see here for the paper that formed the basis for the presentation).

My session notes follow.  As always, these are at-the-time notes.  I make no guaranty as to their accuracy or completeness.

  • The standard return model (bell curve) underestimates fat tails (following Taleb).
  • The “flaw of averages” — average returns over time mean less due to potential extreme outcomes and any category can underperform, even by a lot, over long periods.
  • Average returns focus can ignore risks.
  • Markowitz mean-variance optimization has issues (e.g., the model ignore liabilities — the reasons why one is saving/investing).
  • Paul Kaplan: Deja Vu All Over Again.
  • “Bad crap happens about ten times more often than normal distributions suggest.”
  • James Xiong: Nailing Downside Risk (more here).
  • Standard deviation only helpful as a stand-in for risk when distributions are normal.
  • U.S. REITs and global high yield are dangerous when analyzed with better metrics (fund-of-fund optimization) due to non-normal attributes.
  • Optimizing Manager Structure and Budgeting Manager Risk (nearly as important as Markowitz).
  • “There’s no substitute for common sense.”
  • Re models — garbage in, garbage out.


  • Asset returns are not normally distributed.
  • Investor preferences often go beyond mean and variance.
  • M-CVaR favors assets with higher positive skewness, lower kurtosis, and lower variance.
  • Certain products (e.g., hedge funds) can depart from normal distribution a lot.
  • We need a good fund-of-funds optimizer (recognizes that asset returns are not normally distributed).
  • Idzorek and colleagues are working on it.