The letters below are in response to the article last week Diversification – When More is Less, by David Loeper.  Following these letters is a response from Mr. Loeper.

Dear Editor:

Mr. Loeper should be commended for his advocacy of lower expenses and portfolio simplification, but there are two problems with his analysis.

First, his hypothetical portfolios are constructed in such a way as to compare apples to oranges. In the "Boring" portfolio, there's an allocation of 40% to risk free or low risk assets (intermediate taxable income and cash), while in the "Sophisticated" portfolio, this appears to have been ratcheted down to a weight of 20%. In other words, as the allocation to risky assets is increased by 33% (from 60% in the Boring portfolio to 80% in the Sophisticated portfolio), the implication is that those parties recommending sophisticated allocations would subsume the cash flow component of "wealth management plans with cash flows" to gambles on (slightly) higher returns. Has this been a standard practice among planners, and if so, can it be documented? If not, then the weight of risky assets should be equal in the two portfolios before drawing any conclusions about recent, historical, or future returns.

Second, although he mentions risk-adjusted returns, his data leaves out portfolio volatility, when the primary objective of most "asset allocation academics" is to minimize the risk assumed per unit of desired return. A better analysis would tell us whether, given a particular level of net return (thus accounting for the negative impact of fees and expenses), the sophisticated portfolio offers a significantly lower level of volatility than the boring one (it would also be helpful to know how investment cash flows were accounted for in his performance data). Furthermore, as the old economic adage goes, sunk costs are sunk costs. The proper focus of a portfolio allocation today is not whether it can recover past losses, but rather what kind of lifestyle it can support in the future, and at what risk.

Lower cost and simplification are desirable goals in portfolio design, and this topic is worthy of further study. I would be interested in seeing how well Mr. Loeper's conclusions hold up once the foregoing adjustments are made.

Art Patten
President
Symmetry Capital Management, LLC
Jenkintown, PA

Dear Editor:

David's article presents an unfair comparison.  He compares two portfolios ("boring" and "sophisticated") that have dramatically different cash and fixed income exposures. 

His boring portfolio has 3% cash and 37% intermediate bonds, while his sophisticated portfolio has 0% cash and 20% intermediate bonds. 

Is it any wonder that in 2008 the boring portfolio performed better?  Fixed income and cash are the only survivors (other than inverse funds and some hedge funds). 

He is comparing apples to concrete.

Regards,

Craig L. Israelsen, Ph.D.
Brigham Young University

Dear Editor:

I know Dave Loeper and his analysis follows the old saying “there are lies, damn lies and then there are statistics.” I would have like to have seen these portfolios starting in 1/1/2002; then you would have seen the performance differential of the more diversified portfolio.  Although it under-performed in 2008, it provided a substantial cushion and therefore the clients’ portfolios would have a similar ending value or starting value for the next set of analysis, which is the catch-up chart.

The problem with Monday morning quarterback analysis is the markets are discounting forward mechanisms and not rational backward looking mechanisms. If you owned only investments below the valuation trend line in 2007, you would be in TIPS all year and would have out performed Loeper’s simple allocation by 23%.  Over the next 30 years, I am pretty sure 100% in TIPS is probably not the best strategy, but it will benefit from the strong inflationary period we will soon enter. Nonetheless, I will bet on emerging markets over TIPS if my time horizon is 30 years because TIPS are expensive and emerging markets are cheap.

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