Andrew Lo was recently interviewed by Consuelo Mack on the Wealthtrack program. Professor Lo is one of the leading detractors of the Efficient Markets Hypothesis, starting with his book A Non-Random Walk Down Wall Street. Here’s an interchange about diversification:
CONSUELO MACK: Let’s talk about that, because that’s one of the hallmarks of what you’ve been saying, is that there’s a new definition of diversification. It’s not your grandmother’s diversification. So what is the new definition of diversification that we as individuals can follow?
ANDREW LO: Well, it really has to do with asset classes, as opposed to the number of securities in your portfolio. 30 years ago a well-diversified portfolio was probably 100 stocks and a few bonds.
CONSUELO MACK: U.S. stocks for that matter.
ANDREW LO: That’s right. Exactly. And little by little we’ve made advances, so at some point we went international, at some point we decided to focus on style, value versus growth. At some point we looked at market cap- small cap versus large cap. All those different kind of portfolios lost money last year in 2008. So now we have to focus much more broadly on different asset classes: commodities, currencies, TIPS, real estate.
Obviously, we agree with Dr. Lo. His listing of asset classes essentially defines what is included in the Systematic RS Global Macro portfolio. In addition, other work Dr. Lo has done on his replacement for the Efficient Market Hypothesis, the Adaptive Markets Hypothesis (AMH), shows that it is quite possible to earn excess returns from tactical allocation. As usual in finance, however, progress moves forward one funeral at a time, so it will be decades before many of the false beliefs will be swept away.
(You can read a transcript of Dr. Lo’s interview here. If you prefer the video version of the interview, it can be seen here.)
Click here for disclosures from Dorsey Wright Money Management.
