Pottering About
This month the 2 parts of this post are linked. The first is an assessment of the context for making asset allocation decisions in 2022 and the second part is a reminder of why portfolios need to allow for the unpredictable which in one sense is the only actual certainty! None of us can say we know exactly what events will impact our lives in the future, but we can say that there will be events!
Crystal ball gazing?
We rarely have the opportunity of predicting the future reliably. Naturally, we would like to be able to do so and activities like holiday planning, weather forecasting, getting married and so on are undertaken based on making judgements influenced by our experience, maybe the advice of others and these days some predictions are 100% the outputs of sophisticated computer models.
There is a significant branch of mathematics (statistics) that offers a range of rules and methods to try and deliver at least a way of measuring the probability of certain events happening and those methods are widely used when people try to estimate investment returns.
In the middle of the 20th century, modern portfolio theory (MPT) was devised on the broad assumption that the statistical scientists with their ‘greeks’ (alpha, beta etc) could deduce enough from the past to allow portfolio building to become more of a science and less of a dark art.
In my opinion, that approach is informative but useless on its own. There is clear evidence from all over the investment panoply that past performance is truly not a guide a to the future. Unless we understand why an investment has done well or poorly and the context, both in term of timescale and events, we will never have enough information to make a trading decision.
The process of investing usually requires participation in a market and market behaviour is still mostly human behavior. This means that another branch of science, psychology, comes into play. That is now widely recognised and in the late 20th century the idea of behavioral finance was taken on board by investment market participants.
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