Mohamed A. El-Erian is co-CEO and co-CIO of PIMCO, one of the largest investment management companies in the world.  Previously, he was president and CEO of Harvard Management Company, where he oversaw the university’s $35 billion endowment.  He spent 15 years at the International Monetary Fund, working on policy, capital markets, and multilateral economic issues.  His recent book, When Markets Collide, is available through the link above.

We interviewed Mr. El-Erian on July 16, 2008.

Your asset allocation targets an 8-10% steady state nominal annual return, with 8-12% volatility.  This is in excess of the historical returns on US equity markets.  What are the key factors that will allow investors to achieve these returns?

Let’s start one step one higher.  What will determine success for financial advisors in the coming years?  I believe that, more than ever, it boils down to getting four key factors right: (1) Specifying and implementing an asset allocation that is consistent with the long-term evolution of risk and returns in the market.  This is also a function of the specific objectives and risk tolerance of the individual investor.  The best way to frame this question is to ask “If you had to make a decision and could not touch it for three years, what allocations would you choose?”  (2) Which investment vehicles should be used? (3) How do advisors deal with the fact that individual decisions embedded in investment vehicles may not add up well, especially during a particularly fluid time such as this?, and (4) What else should advisors do about managing risk and, particularly, the “fat tails” on the left side of return distributions?

The primary thesis of my book is that the world is changing so rapidly that all four factors are at play.  So, it matters a great deal how advisors allocate assets, deal with the passive versus active decision, and manage the tail risk.

The reason this matters is that, not only are markets going through a transformation, but the policy and market infrastructure to support these transformations are not equipped to deal with these changes.  There will be market accidents and policy mistakes, and these will be much larger than what we seen in recent past.  I wrote the book before the Bear Stearns saga.  Things are playing out much more quickly than what I expected.

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