Asset allocation was intended to be a means by which to diversify, not an end in itself. Despite ample examples of how insufficiently asset allocation diversifies risk – the Fall of 1998, the dot-com crash of 2000, the high yield debt rout of 2003, the credit crisis of 2008, and so on – the industry overwhelmingly continues to use it as the primary means by which to build portfolios. Part of its persistence as a diversification tool is in its quantitative purity; technically it had been a mathematically correct way to diversify for many years and it conveys a sense of discipline. Furthermore, much of the industry’s quantitative tools and machinery, regulatory structure, language and so on have evolved from several generations of its use. While the world has changed around it, it continues to march on as the dominant method of portfolio construction.
This is an excerpt from our article “The Asset Allocation Merry-Go-Round” published December 16, 2011