Tuesday, April 17, 2012

Tatters and Fringe

When you cannot tell the difference between the carpet and the carpet fringe, the carpet is in tatters. I used to describe the process of asset allocation as "managing the edges", the fringe, if you will. Adding value through small adjustments to the portfolio kept costs low, minimized tax erosion, and gave the largest allocations time to perform. While the board debated between strategies, it was not realistic to choose only growth, or only value; only equity or debt; only public or only private, only alternative or traditional managers. Ranges for each source of return were set and then we "managed the edges" to achieve the best relative return possible.

The great assumption was that the strategies were uncorrelated, and would not all move in the same direction at once. If they did it was called an anomaly and discarded as an unreliable data point. Its remarkable how many investment advisors still subscribe to this. In fact, investment advisors who don't are regarded as "the Fringe".

Today managing the edges is not enough. There are no edges to manage, and its time to reweave the carpet.


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