E161: The Death of Modern Portfolio Theory? w/John Bowman
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Why is liquidity considered a challenge in investing?
I've listened to interviews with Stan Drunkenmiller. I spoke to Cliff Asness about this, about the difficulty of doing the right action in difficult times. Liquidity is actually not a negative because it tempts you into wrong actions. You sell at the exact wrong time when there's a drawdown just because of human evolutionary purposes. What do you think about that? We certainly have a fetish with liquidity. The industry, I think we've been conditioned, and look, not just the public and the clients, but the industry, to your point, has probably conditioned individuals to think about liquidity as table stakes, as a starting point, as a required level setting to have further discussion. And that is a I think an unwinding dialogue that's currently going on in the business.
I think you're right. There's some extent in which liquidity or illiquidity, I should say, protects us from the worst parts of ourselves. Today, I'm excited to welcome John Bowman. John, a seasoned expert in asset allocation and the CEO of Kaya, shares his insights on the evolution of asset management from the traditional bucketed approach to a total portfolio approach. We'll explore the nuances of optimizing investment strategies around client goals rather than asset buckets, the blurring lines between asset classes themselves, and what the top pension funds, endowments, foundations, and family offices are are doing today that differentiates them from their peers. Without further ado, here's my conversation with John.
So asset allocators are moving from a bucketed portfolio approach to a total portfolio approach. Talk to me about the evolution. Yeah, as you probably know, David, and as many listeners, I hope, have realized Kai's been doing a lot of work on TPA or total portfolio approach, as you said. I think there's some important context needed here Because all of us have been kind of swimming in the water of modern portfolio theory for our entire careers. Harry Markowitz, God rest his soul, passed away a couple of years ago, had invented modern portfolio theory. And many of its offspring are apparatus that have been normalized, have been kind of, as I said, the water we swim in. That's things like strategic asset allocation and efficient frontier and the idea of asset class taxonomy. benchmarking at the asset class level.
All of this came out of Markowitz's work. And of course, all of us then were taught this through academia, through credentials like Kaya, through our apprenticeship as we grew up and an entire industry. The consultants grew up around supporting this approach to structuring portfolios, bucketing, as you say, David. I think more recently, folks have stepped back, the more sophisticated asset owners, and just asked the question, not whether MPT and SAA have failed, but is there actually a more optimal way to build portfolios on behalf of clients? The idea being that SAA, by definition, optimizes at the asset class level, individual buckets, to use your word, whereas TPA is meant to optimize around the total portfolio. The idea that you start with the client's goal, so it could be a spending rate for a university, could be an actuarial rate if you're a public pension company, And it could be a goal if you were a high net worth family.
And then building a series of strategies and assets that really support that particular approach rather than being constrained and handcuffed by these arbitrary structures along the way. Just to play devil's advocate, the bucketed approach, you might have a certain percentage for private equity, a certain percentage for venture capital, a certain percentage for private credit. But the purpose of it is to come out to a specific risk return between some target return with lower volatility. How is that any different than using a total portfolio approach? It's a great question. And the guardrails that you're describing, the idea of diversification, the idea of ensuring that you're trying to constrain volatility, the idea of stuffing or mashing together different behaving correlations and risk premia, all of that, all those attributes that we subscribe to as part of kind of the worldview in which how to build portfolios is still very much the case.
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Chapters
4 chaptersSpeakers
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