Mark Kritzman - “We Have to Question the Assumptions that Underpin Our Models... Nothing is Simple" | #51

The Meb Faber Show

In Episode 51, we welcome Mark Kritzman. Per usual, we start with Mark’s background. He tells us a bit about his 40-year career in investing, leading to Windham, where he focuses on asset allocation and risk premia strategies.

But it’s not long before the guys jump in, starting with Mark’s 7th book, A Practitioner’s Guide to Asset Allocation, which will be coming out soon. Mark describes the process of asset allocation, starting with the basics, then taking us a layer deeper, discussing asset allocation as a way to balance the goal of increasing wealth while minimizing drawdowns. In essence, you need to identify the asset classes you want, evaluate their expected, long-term returns, then estimate the volatility of each and – just as importantly – estimate the correlation between the asset classes. With all this, you then find the particular allocations that give you the highest return for the same level of risk – the efficient frontier.

Next, the conversation takes a turn toward investing fallacies, including the idea that asset allocation drives more than 90% of performance. Mark tells us there are some flaws with this idea, then explains in detail. Another fallacy discussed is that of time-diversification – the assumption that investing over the long-term is safer than investing over shorter periods. Again, Mark provides details that call into question this belief.

The guys then get into investing in illiquid assets, and how to appropriately structure them in an asset allocation. It can be hard to maintain a balanced portfolio consisting of illiquid assets. Mark’s approach is to treat liquidity as a shadow investment. In essence, you attach a shadow asset as well as a shadow liability to the appropriate parts of the portfolio. You’ll want to listen to this part of the episode for all the details.

This dovetails into hedge funds, since hedge fund investing can also be illiquid. Meb asks how Mark thinks about hedge fund investing, and given limited information, is an investor’s only recourse to be able to pick the best managers? And if one doesn’t have that ability, should he/she just stick with investing in the S&P?

Mark has a great answer about how most of the historical premium of private equity over public equity can be attributed to the sector exposures of private equity funds. So investors can build a portfolio of public sector ETFs in a way that can approximate much of the hedge fund sector allocation. You’re probably going to be surprised at just how much of the premium of private equity over public equity doing this which would have delivered to an investor.

As usual, there’s plenty more in this episode: the role of fees and taxes… the concept of “turbulence”… the absorption ratio, and how we can use it to evaluate risk… and lastly, what Mark’s most useful idea is for listeners.

What is it? Find out in Episode 51.

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