SmartETF

Managing Portfolio Allocations With ETFs

Where are your asset classes? You have 11 industries, yet you have 10.8% in financials. What about foreign securities? What about real estate, commodities, or alternatives? Secondly, where is the investment selection process? I don’t see how any asset allocation software could deliver the asset allocation mix you own. Thirdly, where is your risk management? If you change your risk model to Conditional VaR (Expected Shortfall) and weight your data using GARCH you would have avoided financials all together.
Diversifying assets following the concepts asset allocation is not true portfolio optimization. You might enjoy reading Mandelbrot’s book ‘The (Mis) Behavior of Markets to better understand the newer asset allocation strategies like Extreme Value Theory. Cheers

The Problem With Designer ETFs

You make an argument for market cap weighting but I question several of your assumptions: 1) that Wall Street hires the best minds, 2) market distributions are accurate, 3) and that market cap represents the market. I’ve met thousands of investment professionals and most follow the heard and few do their own homework. For example, look at the bulk of the asset allocation models that use off the shelf models, like Ibbotson. These models are ridiculously flawed; in fact the founder of CAPM, Bill Sharpe, even admits that. Just because everyone is making a bet that history will forecast the future (based on a regression to the mean) doesn’t make it right. This leads to point two, most distributions fall under the Normal Distribution category which by default ignores the fat-tails. But more to your point why is following the heard a good thing? Cap-weighting is a form of market-timing because it is momentum based, like it or not. Someone is over-paying for an asset because you have more buyers chasing an asset as the price is rising. Regardless of what you believe Market Cap is a strategy and who is to say which is right? I think Rob Arnott has more than proven his point. You discuss the statistical distribution of money but you are only looking at the effect and not the cause. Much more insight can be garnered by analyzing the distribution of institutional (block) vs. non-block trading volume. Doing so you soon realize you can have more buyers than sellers and yet the price can still fall if some of those sellers are big block institutions. Watch how often the big boys are selling into the strength of the smaller volume buyers; not a pretty sight. In other words, it’s the human judgment that you endorse (perhaps based off of investor sentiment) that leads to the over-bought or over-sold conditions. I have the most trouble with your comment ‘You can’t outsmart the market by basing your distribution of money between stocks on a rigid computer analysis of part of the data.’ I totally disagree; tell this to Simons, Tudor, Robertson or most of the quant hedge fund mangers. I build models that have out-performed for decades. Maybe you should have added: ‘…using traditional models like Modern Portfolio Theory’ or something to that sort. If it doesn’t make sense to you feel free to contact me and I’ll demonstrably spell it out. More confusing to me is that you defend market cap and then later in your article start making a case for a secondary weighting to adjust for human behavior (market sentiment); isn’t this contrary to your point? Market Cap is not a function of democracy; it is a greater fool theory. If it is a democracy it is one like most countries where a few fat cats pull the strings behind the curtains and influence the tide (institutional block money flow, or worse (if you’re into the conspiracy theorist thing)). My suggestion is to not drink the random-walk cool-aid. Maybe a nice book by Benoit Mandlebrot or Nassim Taleb or anyone else that can live outside the traditionalist will change your mind. Cheers.