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Asset Allocation - Rethinking Diversification

Portfolio construction has always been about putting an investment portfolio together in the simplest way that takes an agnostic approach to future asset returns and risks. The investor seeks to separate the strategic from the tactical, stepping back from forecasts and allocating for the long term, independent of market views.

Harry Markowitz in 1950 established the idea of the efficient frontier, laying the foundations of portfolio theory, the principles of which still stand. We suggest the following three steps can be used to address the portfolio construction challenge:

• Decide on the sources of return for which there is a fundamental reason. Not all risks are rewarded.

• Combine these, using available asset classes, in the way most neutral to a view on their future behavior. Do not introduce spurious dependence on uncertain estimates.

• Scale the overall allocation to meet the return target and risk budget of the investor.

The obvious outcome of such principles is a portfolio which has at its core (but is not limited to) an allocation to liquid markets according with the risk parity principle.

http://blog.redington.co.uk/Articles/Dan-Mikulskis/June-2013/21ST-CENTURY-PORTFOLIO-CONSTRUCTION.aspx

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.