Mandelbrot Speaks Out (Loudly)

The FT has 17 minutes of video interview with Benoit Mandelbrot that covers why efficient market hypothesis is wrong and why “new” theories need to found or maybe more correctly new theories need to be looked for. This is time well spent.

It is silly for a lightweight like me to dissect Mandelbrot but exploring the long term implications could be interesting. Thoughts on the evolution of portfolio construction and management provide never ending reading appeal to me.

It has been abundantly clear that there is very little interest in the profession in staking new ground, being early adapters of new products, seekers of new themes and explorers of new methods which I believe is a huge disservice to clients.

A perfect example is the extent to which after the bear market of 2000-2002 many advisors went back to domestic equities only to get bull market returns well below normal as compared to past domestic bull markets. The S&P 500 went up about 100% versus the normal 180%.

On the other hand advisors willing to do the legwork needed to see the very obvious move afoot in emerging markets and who then allocated to the space delivered real value to clients over the cycle. Ditto commodities. Previously these segments were not included in the typical investment policy but REITs were. Of course this worked out very badly in terms of opportunity cost for not owning the former and real losses for owning the latter.

Looking forward, aside from my usual prattle about owning foreign stocks, I believe it will be very important to own foreign sovereign debt both for the dampening of portfolio volatility and the erosion (not implosion) of the US dollar. Individual issues are difficult to access unless buying $100,000 minimum is suitable for you. There are some ETFs and mutual funds and I expect there will be more in the coming years to make this happen.

In addition to the above there will have to be a thorough study of what risk means and then what risks we are willing to take. I do not think, contrary to articles we are seeing lately, that 60/40 should mean 60% bonds but people will need to consider more tactical action in their equity portfolios. This will draw hoots and howls from the diehard passive indexers but so be it.