Active Asset Allocation

Jahnke, William
January 2003
Journal of Financial Planning;Jan2003, Vol. 16 Issue 1, p38
Academic Journal
This article focuses on active asset allocation in investment and financial planning. Investment management is organized around asset allocation and security selection. When it comes to asset allocation, two assumptions are commonly, but not necessarily employed: markets are efficient and the process that generates return is stable. These assumptions are false. One of the seductive ideas that crept into common practice over the last decade is the idea that serious attempts to value asset classes and forecast asset class returns are a waste of time. The core problem with this approach is that it leads to asset allocation solutions that are inconsistent with long-term financial objectives. According to a number of commentators, the lesson to be drawn from the current bear market is the importance of diversification. The practice of decoupling asset allocation solutions from investment fundamentals is due to the confluence of two factors: the historical performance of the stock market relative to the bond market and the selective use of academic arguments regarding asset pricing and portfolio theory. Because of the imprecision in forecasting returns, asset allocation solutions are only rough approximations of so-called optimal solutions. With uncertainty in forecasting the fundamental variables going into the return projections, appropriate asset allocation solutions operate in a wide range at any point in time. There is no getting around the need to engage in active asset allocation. Static, passive and market-weighted asset allocation are not defensible approaches where markets are not efficient, and the process that generates the distribution of returns is not stable.


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