Tuesday, November 5, 2013

Asset Allocation and Risk-Return Analysis

 
 by Roger C. Gibson


by Harry Markowitz

I decided to review these books together because the subject matter is quite similar, yet the approaches of the two authors couldn't be more different. Harry Markowitz is a Nobel Prize winner who more or less defined the concept of risk in investments and how to weigh it in the construction of a portfolio.  Roger Gibson, on the other hand, is a financial adviser with many years of experience and a unique view on balancing a portfolio to limit risk and maximize profit. Both advocate asset class and securities mixes that lead to portfolio diversification and limit risk. Markowitz does it with lengthy examples and complex formulas. Gibson does it with hypothetical portfolios and performance evaluation of investment classes.

Markowitz’s book, which is the first of four volumes on this ostensibly deep subject, is much like a college textbook. The financial jargon is at times a slog, and the formulas are nearly incomprehensible without an advanced mathematics degree. The parts that can be understood by the typical layman (like me), however, are interesting and useful. They make it very possible to analyze one’s own portfolio in the light of Markowitz’s experience and research, and that should lead to risk minimizing, return maximizing portfolio.

Gibson’s book does not suffer from the academic bent that afflicts Markowitz’s book, but it does have the drawback of being partially directed toward financial planners and investment advisers.  He shows historical trends and their effect on hypothetical portfolios, and then strengthens his argument with critical analysis of the performance of various asset classes during up, down, and sideways markets. The heart of his strategy ends up being diversification, rebalancing, and risk avoidance which individual investors and investment advisers can put to work in their personal and client portfolios. He then spends the last third of the book explaining how an investment adviser can analyze a client’s risk tolerance and use the principals contained in the book to build a suitable portfolio. Some people will find this interesting and useful, but as a long time investor who is not a CFA or investment adviser, I found it to be not that useful.

Risk-return analysis and risk avoidance are important cornerstones of any investment strategy, which is what makes these books so important. Without the benefit of the other three volumes of Markowitz’s work, and not needing the investment adviser sections of Gibson’s work, it’s hard to give them full marks for their books, but the material that is pertinent and understandable is so valuable, that a four-and-a-half dollar mark for each is more than justifiable.

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