Skjellifetti

Checking In on the All-ETF Portfolio

From your Feb article [my substitution]:

If we have [$BLACK_SWAN], the short-term losses to any portfolio are likely to be far greater than Quantext Portfolio Planner or any other portfolio model can estimate. This kind of massive disruptive event is not what these models are capable of estimating.

...

Ultimately, portfolio models are perhaps most useful because they give investors objective tools to:

1. examine diversification benefits in their portfolios
2. estimate total portfolio risk (albeit not very well for market crashes, wars, epidemics, etc.)
3. estimate total portfolio returns in light of assumptions

It is point number two that I was trying to highlight. MPT is all about creating portfolios with the best return for a given amount of risk. But if we are doing a poor job of estimating risk, then it is not at all clear that we are, in fact, maximizing expected returns per unit of risk. Tools such as QPP may thus be giving us a false sense of security when they recommend, say, a concentrated position in Malaysia over a larger more diversified basket of emerging market stocks.

Checking In on the All-ETF Portfolio

This may also show the limits of using MPT for divining the best risk-adjusted allocations. You have 5% devoted to Malaysia. But in 1998, during the Asian crisis, Malaysia, IIRC, put strict limits on the repatriation of international investments. That would have meant that 5% of your portfolio was suddenly unavailable. How does a tool like QPP account for this kind of risk (or is this uncertainty)?

I'm not a big fan of Nassim Taleb. He is a terrible writer who is guilty of some egregious rhetorical fallacies. But his main point, that MPT has a terrible time coping with the unknown and that it is this kind of uncertainty that is the biggest source of investment losses, is spot on. That QPP would include Malaysia in a hypothetical best risk-adjusted portfolio is a good example of Taleb's point.