Markowitz & MPT

Is MPT dead?

So what are we?

And what are we looking for?

To con!ince clients we had magic

We could look at different asset classes and based on Nobel Prize winning mathematics redict which combination of in!estments would minimize risk and ma"imize returns #efinitel$ worth our small fees of %& or '& or whate!er And it has ne!er been true

D e M i g u e l , Vi c t o r, L o r e n z o G a r l a p p i & R a m a n U p p a l M a y 3 1 , 2 0 0 5 , o ! " n e ## i c i e n t i $ t % e 1 & ' ( $ $ e t ) ( l l o c a t i o n * t r a t e g y +

(The %)N asset allocation rule t$ icall$ has a higher out*of*sam le Shar e +atio, a higher certaint$* e-ui!alent !alue, and a lower turno!er than o timal asset allocation olicies.

/fficient frontier does not

Efficient frontier does worse:

redict

*%orter t%e $erie$ o# ,ata, Lo!er t%e -olatility o# t%e in,i-i,ual a$$et$ or a$$et cla$$e$, .%e greater t%e num/er o# a$$et cla$$e$
How much worse does it do?

"# -olatility !a$ 200 !it% 1 a$$et cla$$e$ it re2uire, 50 year$ o# ,ata
#or 34 to ,o a$ !ell a$ a 1&' $trategy5

"ncrea$e t%e num/er o# a$$et$ #rom 1 to 100 it !oul, re2uire t%e

e$timation !in,o! in e6ce$$ o# 1,000 year$5

And ne!er has

So we must do something else to make our redictions work 4 $es?

Add more asset classes?
0urrenc$ 1a bet2 3old 1a bet2 Alternati!es or hedges 1a bet2

In!ent s ecialized in!estments based on (bets. and call them (structured roducts. Tell in!estors MPT is dead and that we ha!e some new (magic tricks. based on our $ears of e" erience

#on5t we get it $et?

/!er$ academic stud$ from e!er$ countr$ of all forms of acti!e 4 redicti!e strateg$ shows it does not work6 And there is worse news

There are big cheaters

In!estment banks ha!e created %7" the ca italization of e!er$ stock market on /arth in zero*sum games and sell them as in!estments No new news, but we ha!e found that big firms cheat reall$ big all in the name of rofits and bonuses
Subordinated debt 4 cheating for billions of 8 Mani ulating 9ibor rates affecting trillions of 8

So how can our asset allocation redictions work if eo le can mani ulate the markets?

:h $eah, it doesn5t redict;

Ma$be we are not this gu$

<ut these gu$s6 #isco!ering an uncertain world along with our clients6

And asset allocation is not to redict but;

A wa$ to su ort a longtime strateg$ of di!ersification 4 di!ersification of in!estments, of currenc$, of risk6 A wa$ to come u with some more ob=ecti!e assum tions to use in the financial lans for a client And a useful aradigm to ro!ide a structure to tr$ and get clients not to be sub=ect to the lemming like in!estment beha!iour romoted b$ the media and much of the industr$6

What's wrong
with

Markowitz and P/MPT?

Zoltan Luttenberger PhD
Monaco 2013

Modeling Illusion
Mixing up

Model AND Reality

Psychology of planning... just works ... in this way:

Monaco 2013 - Luttenberger

Temptation of
1. Forgetting Assumptions 2. Taking Functions as guaranteed 3. Shifting liability to the tools... and their vendors and "promoters"

"Out of the box planning"

Monaco 2013 - Luttenberger

Adressing Shortfalls
"More" modeling... "More" science... shall replace ... Common sense AND

"Out of the box thinking" ???

Monaco 2013 - Luttenberger

Question: Asset Classes

Is Cash or Gvt. Bond safe??? Is Emerging risky??? Is Property risky??? Is Gold volatile???
... just a few questions from the clients... on the "Deficient Frontier".

Monaco 2013 - Luttenberger

Question: CPI

Monaco 2013 - Luttenberger

Question: Model framework

Are Variables actually random? Are Parameters (and functions...) stable? Is data Input relevant?

WHAT IF ... Wrong or a Paradigm Shift???

Monaco 2013 - Luttenberger

More questions...
AMI - Monetary Reform Paul Craig Roberts Chicago Plan World Currency Statistics Euro 101 ...

Monaco 2013 - Luttenberger