Beyond modern portfolio theory

Tactical asset allocation seems plausible and it does work -- sometimes.

Gail Bebee 7 August, 2015 | 5:00PM

Do you know the asset-class mix of your fund-of-funds portfolio, and what's behind it?

Managed portfolios offered to individual investors are mostly constructed using modern portfolio theory, which was pioneered by Harry Markowitz, an economist whose resumé includes a Nobel Prize in economics. The theory proposes that for a given risk level (defined as variability in returns), poorly correlated asset classes can be combined to create an "efficient frontier" portfolio that optimizes the expected investment returns. Building such a portfolio involves determining the risk an investor will accept, selecting the optimum asset mix for this risk level, and researching and buying investments to achieve the chosen asset mix.

While modern portfolio theory is prevalent in the investment industry, not all money managers worship at the efficient-frontier altar. Among the non-believers is RiverFront Investment Group LLC, based in Richmond, Virginia, which employs a more active approach to portfolio construction that it calls dynamic investing. Within the investment industry, this type of discipline is commonly known as tactical asset allocation.

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About Author

Gail Bebee

Gail Bebee  Gail Bebee is an independent personal finance speaker, teacher and the author of No Hype--The Straight Goods on Investing Your Money. She can be reached at gbebee@gailbebee.com; her website is www.gailbebee.com.

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