Andrew Allentuck

Monday, May 19, 2003


The Art of Asset Allocation: Asset Allocation Principles and Investment Strategies for Any Market
by David M. Darst
McGraw-Hill, 2003
396 pages
ISBN 0-07-137950-9

Asset allocation as an academic theory is based on the observation that various asset categories have different amounts of covariance. By blending bonds and stocks and then refining the blend to domestic bonds and global government bonds, high yield bonds, small cap stocks, large cap stocks, global equities, etc. one should be able to increase return while lowering portfolio volatility.

Mr. Darst, Yale first degree, Harvard MBA, runs private client services for Morgan Stanley in New York. Not surprisingly, his book is solid, though it makes more of asset allocation than this subfield of investing deserves.

Asset allocation is a strategy for the cynical or the agnostic who believe that they cannot do very well spotting trends and moving money or who are reluctant to trigger trading costs or capital gains or losses just on hunches hunches about the future.

Asset allocation is a breakthrough for the mathematically timid who believe that an elliptical function mapped into space defined as expected return on one axis and risk on the other have discovered something. Convexity conditions, which is what asset allocation is really all about, express optimization operations in all sorts of space. If we know that CEOs of different hair colour do best in different markets, then we could plot blondes and redheads and even bald guys against their market conditions and come up with a kind of optimization map for hair colour and portfolio returns. The more uncorrelated returns by CEO hair colour are, the better the curve of the upper left quadrant of the ellipse and the stronger the case for investing by hair colour.

Mr. Darst admits as much in noting that asset allocation models are just computational systems, not, as he says, "solutions encompassing great quantities of wisdom and judgment."

So asset allocation is not the final, ultimate stage of portfolio management. As far as we know, Warren Buffett does not worry about how he holds his beverage business vs. his investment in a shaving cream company, carpets, chocolate or insurance. In other words, an investor can do fine without asset allocation.

The advantage of asset allocation is that it provides a framework for rebalancing assets as they rise or fall in value. I think that is what makes study of this field of portfolio management worthwhile. To that end, in the context of private client services, this is quite a good book.