Robert Carver was helpful enough to offer me some guidance on Quantopian regarding the use of the scipy.optimize.minimize function as used in Markowitz style asset allocation (selecting weights based on co-variance and performance).
It lead me to muse on the absurdity of hard, specific advice in finance and investment. Markets are chaotic adaptive systems with feedback loops and in the absence of a non probabilistic edge, trading is probably a zero sum game. By non probabilistic edge I mean some edge based on MORE than mere probability. Probability is all well and good but of limited use in devising trading systems. The most successful trading systems rely on a real, tangible edge – the bid offer spread, reaping contango, buying asset at a deep discount to the market like the private equity firms do. Or indeed on less legal methods.
I think the general Markowitz type of approach for long term investment is a good one used in conjunction with rebalancing on a periodic basis. I keep having to remind myself however that finance is NOT a science. And that any asset allocation strategy (including straightforward 60/40 methods) will assuredly not produce identical metrics in forward investment as it has shown in back testing.
But in an imperfect world we all have to make assumptions and unless I am “trading” something with a built in market bias/advantage, I prefer at least an attempt to achieve a half sensible weighting scheme on a widely diversified portfolio of instruments than any other approach as far as investment is concerned.
On another point, as to the advantages or disadvantages of the Markowitz or indeed any other approach to asset allocation, I am ever more acutely aware that there is no single truth or answer or indeed any agreement in general. Diversification is good (?) (even essential in my view) unless you can predict the future – but even so, there are many people who would dispute that forcibly. Particularly among avid stock pickers and hedge fund managers who tend to load up the truck when they see a “good” opportunity.
I am putting out a product (the GBA Workbench) in conjunction with my computer scientist partner to let people run, in the cloud, simple tests on a number of different asset allocation techniques. These days I am totally averse to pushing any one approach or even stating any personal preference for any approach. Were I to write another book (god forbid – the last one was a total waste of time vanity project) I would emphasise until blue in the face that (as far as we are currently aware) the future is unknowable and that therefore the only logical way to invest for the long term is to spread the assets over as wide a field as possible. To diversify over currencies, economies, politics, tax regimes and of course product providers (banks, custodians, fund managers). And to operate some sort of periodic re-balancing and re-weighting technique. Rome eventually fell; the empire of the United States of America will also fall. Japan “fell”. China will eventually follow Imperial Russia, Weimar Germany and the Hittite civilisation into oblivion. So keep diversified.
I’m only rambling on since I tend to be asked to speak or write or “do” stuff surrounding investments. I mostly turn such opportunities down since I believe most advice including my own is biased and unreliable and that I would be better off keeping my mouth shut. And I am deeply averse to appearing in public claiming any “expertise”. I do not possess any.
In terms of future writing and the cloud based back tester I am offering what this boils down to is admitting “I don’t know”. I am happy to present investors with some of the more apparently sensible and straightforward asset allocation techniques and leave them to make up their own minds whether such approaches have any value or not.
Markowitz may have its problems…well documented. But investment and indeed life is one big problem and it is a question of trying to steer between scylla and charybdis.