systemseeker

Book Review: 'The Intelligent Portfolio' by Christopher Jones

I've read the book, and give it more credit. The chapter on expenses vs. diversification is alone worth the book's price. Diversification must be weighed against its cost, and the lost diversification benefit is vanishingly small compared to differences in fund expenses.

You state Financial Engines advocates a static portfolio, but actually it doesn't -- the recommended portfolio will shift as the market portfolio changes, and as betas change. Granted those are small changes, but nonetheless reflect the best information the market gives us on optimal asset allocation. As the book argues that diverging from that is making a 'bet'.

Regarding REITs and commodities, these are already implicitly included in a broad-based equity index; any heavier weighting them is, again, a 'bet'.

The book makes the case that even rebalancing back to 'target allocations' is (implicitly) a contrarian 'bet'!

Geoff, while I have much regard for your work, after comparing the QPP with Financial Engines, I'm leaning toward FE. The problem I have with QPP is the "Average Annual Return" you generate for the portfolio, is based upon historical annual returns of each asset. So, for instance, QPP ends up telling me I should bias my portfolio toward VEIEX (Vanguard EM), just because it's had good past returns. How can I trust that? FE, on the other hand, uses only past volatility and market correlation to extrapolate future returns. That's a safe assumption, and the book makes the case for that instead of historical returns. You'd need 1500 years of historical data to estimate an average annual return to within +/- 1%.

My one major worry with FE's recommendations is the tilt toward growth over value. I understand that growth has greater beta, but how do we reconcile this with the Fama/French research? The book only says, in passing, that value stocks must contain other risks not represented in the volatility of their returns. That is unsatisfying.

Overall though, I though the book was hard to argue with. Geoff, I appreciate hearing your perspective on it. Thanks for your review.