The investment paradigm used by most institutional investors today is dominated by several practices that have evolved over the past 30 years: (1) Asset allocation determined primarily by mean-variance optimization, (2) investment committee governance structure that is dominated by quarterly meetings and quarterly decisions, (3) a carving up of the investment landscape into investment styles, (4) focus on relative investment returns, (5) a belief that diversification makes volatile asset classes palatable, and (6) a focus on strategic asset allocation, ignoring tactical approaches.
The financial crisis has resulted in many investment professionals and institutional investors questioning this paradigm. The failure of these practices was identified by several different outcomes: (1) investment returns during the past year were significantly below worst case returns predicted by mean-variance optimization, (2) investment committee governance structure resulted in a lack of nimbleness in the face of rapidly changing capital markets, (3) very little academic evidence to support style boxes, (4) relative returns may come at the expense of capital preservation, (5) increased correlations resulted in reduced diversification effect, and (6) a single-minded focus on strategic asset allocation targets in spite of deteriorating market fundamentals may have exacerbated losses.
This session will examine these investment practices and other related issues, explain how each practice developed, discuss relative strengths and weaknesses, explain what went wrong during the financial crisis and propose alternative paradigms.
This topic will directly challenge conventional thinking and offer a perspective that will be of compelling interest as healthcare systems struggle with dramatically reduced financial assets and investment income.