Thursday, March 12, 2009

Debunking Modern Portfolio Theory

Blogger Jasonred79 said...

Those who were shorting financial stocks are UP by 30%, easily... so being -30% is not such a great achievement... Though I don't know if those rules allow that.

Anyhow, I'm pretty sure you're out of the running to win this thing... the leaderboard are definitely all showing strong gains.

9:18 PM

Blogger Salvatore_Dali said...


i am not running the fund as a hedge thing... i am trying to be near fully invested and still beat the S&P500...

yes, you may notch gains of 20% or even 30% when the index is down 40% but that would have involved huge stock or sector bets, e.g. shorting financials ETF etc... thats one way to run a fund

i am using the fund to match wits with the S&P500, not looking at absolute returns per se... if I was, I would be all cashed up from August till now... 0% would have beaten the mkts by 41% but that would have been senseless.

9:44 PM

Blogger ikanair said...

It's this what it have become of?
To lose less is to be considered good?

No wait.... wait...

The (un)holy trinity (subprime, us consumer and china) is playing out right.

Then maybe you will just lose 80% and S&P lose 90%, and you are still good. any may they give you a million dollar fund manager job.


10:45 PM

Blogger Salvatore_Dali said...


u can laugh but thats portfolio mgmt... ask any fund manager... u just have to beat the index, u r judged by being fully invested... i told u its quirky but thats the way the dice rolls...

if the index is down 10%, for you to make +40%, you would have to shy away completely from a balanced portfolio... you would have had to make huge sector or stock bets, e.g. put 70% in KNM...

I am not saying that is wrong, that is a genuine stock picker model, if u can do that well, go be a hedge fund guy... but if you r managing a proper portfolio using modern portfolio theory, you basically aim to beat the index, based on the premise that:

over the long run stocks offer superior returns (we now know how silly that assumption is)

hence if you consistently beat the index, over the long run, you should have superior returns (we also know that is not entirely true)

we can laugh at modern portfolio theory n ask them to chuck the textbooks... thats like telling you son not to get business degrees cos they teach u shit... but you still send yr kids to college cause thats the way things are done...

So, guys, I agree with what you are saying but you have to appreciate modern portfolio theory. Yes, many assumptions may have been proven to be shaky at best but we do not have much of an alternative. Yes, you can be a pure stock picker/sector allocator, but by doing that your "risk profile" will be raised enormously to such an extent that no funds will be given to you to manage. Even though people will say they look at absolute performance, but these pension funds will cite terms like your alphas, betas and more importantly your R2 - all having to do with your risk profile, your risk taking to generate your returns. So, we all can laugh at why a -30% return is better than -40%, but it will put you in better framework when you appreciate the overall interacting factors.

p/s photos: Maki Nishiyama


YNH said...

to beat s&p is really good enough

i mean if the index go down by 20%, it probably reflects the market value of all listed companies down by 20%. hence the wealth destruction to those who long.

in such market system, i do think that if u beat s&p, ur real income would most probably rise. because the others are losing money more than u, tightening demand shud slowly leads to defaltion.

Jasonred79 said...

Well, if you wanted to trash the index and equivalent of keeping cash, you could short 35%, long 35% and keep 30% cash.

Modern Portfolio theory is the big hope for all those fellas who are running GUARANTEED RETURN FUNDS... seriously, what happened to all those fellas who bought those things when the KLCI was 1400 and HK market was at the top? ... if the markets have not reached that level by that point in time, does that mean that someone is going to have to make up the difference out of their own pocket?

From job security as fund manager's perspective, you are 100% correct of course.

From the perspective of someone who has money in the market, -30% is not funny at all...

Personally though, I would not want to put my money into your hands... lol, but that's because i don't give my money to fund managers, period. ... and that was before I found out this 65% invested rule... (YET another occasion Dali corrects my ignorance). ... So, basically, no matter HOW BAD the economy gets, no matter how awful or horrific the outlook is, fund managers MUST be 65% invested? ... hmmm... that sucks... honestly, it seems a silly rule to me. *shrugs*

Does that 65% include buying bonds?

DanielXX said...

One of the myths in fund management is index benchmarking. If you have a dividend-reinvested fund benchmarked against an index which has to face dividend being siphoned off the components every year, it's not such a great deal to beat that index. Expense ratios are typically lower than dividend yields so it's easy to outperform. Just mimic the index and you can outperform it already!

WY said...

will risk-adjusted return (such as Sharpe ratio) be a better benchmark in fund management ?
(but I didn't see it being used in the industry)

DanielXX has a point.
I wonder whether those indices benchmarked have considered the dividend component.

Modern Portfolio Theory is insightful. However, the user has to check & judge whether the assumptions are still true and how to adjust to reflect the real.
User should not use it blindly and blame it when it goes wrong.