The New Science of Asset Allocation: Risk Management in a Multi-Asset World

CHAPTER 1

A Brief History of Asset Allocation

For most investors, asset allocation and its meaning seems relatively straightforward, that is, the process of allocating assets. It is the how and the why of asset allocation that has led to an entire asset management industry dedicated to its operation. Given the amount of resources and effort dedicated to understanding asset allocation, it would be reasonable to expect that after almost 5,000 years of human history there would be a suitable solution. The fact that the investment management industry is still groping for an answer is illustrated in the millions of references to “asset allocation” from any Internet search and the fact that there are enough practitioner books and academic articles on “how to allocate assets” to fill any investor’s library. This chapter provides a brief history of how major advances in financial theory and investment practice affected investors’ approach to asset allocation and how asset allocation has had to evolve to meet changes in economic, regulatory, and technological environments. However, given the range of current and past efforts to diagnose, describe, and prescribe the process of asset allocation, it seems relatively futile to provide any reasonable summary of how we got here, much less what “here” is.

Before reviewing how we have arrived at current approaches to asset allocation, a brief review of what asset allocation is seems appropriate. Simply put, the ability to estimate what the future ...