R. A. Ferri - All About Asset Allocation (III)
June 9, 2007Thanks for visiting! If you like what you're reading, you may want to subscribe to my RSS feed.
This is the third part of my book review for Richard Ferri’s “All About Asset Allocation”. If you haven’t read the previous parts, I strongly suggest you do here.
Chapter 4 - Multi-Asset-Class Investing
The key idea to take away from this chapter is that adding multiple asset classes pushes the portfolio risk and return toward the Northwest Quadrant. This means that you’ll get higher returns at a constant, or even reduced, risk level. Obviously you should strive for the best asset allocation possible, but the idea of the perfect portfolio is just an utopia. Ferri repeatedly reminds you not to forget that.
Ferri provides a short list of points to bear in mind when building a portfolio:
- The future risk, returns, and asset-class correlations cannot be known with any degree of certainty.
- A portfolio with more asset classes is better than a portfolio with fewer asset classes.
- The best portfolio you can design is one that fits your needs.
Especially the last point is of importance for the whole concept of asset allocation, because you will only keep re-balancing and stick to the originally designed allocation if you’re completely comfortable with your selections.
And just when you thought you’ve heard enough warnings and points to bear in mind when designing your portfolio, he leaves you with another list of just as important facts to take away before you are allowed to learn more about the individual assets available and the design process that comes with them.
This time, Ferri sums up important points about the correlation between asset classes:
- It is very rare to find low-cost investable asset classes that are negatively correlated or even noncorrelated with each other.
- The correlation between asset classes can change.
- During a time of extreme volatility, positive correlation can increase dramatically.
The author illustrates the last point by mentioning that after 9/11 all stock markets around the world fell by more than 5% and that no diversification could have found a way around this.
An extensive example portfolio is given in this chapter as well, but it only illustrates the key points mentioned above so I won’t go into any more detail on it here. After all, you might still decide to read the book after reading my reviews, so you should be getting some extra information for your money… 
Chapter 4 is the last chapter in part 1 of the book, so the next review will dive into part 2 which covers the most important and most widely available asset classes that you might want to add into your portfolio.
