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

CHAPTER 11

The Importance of Discretion in Asset Allocation Decisions

Asset allocation is a discipline of judgments and decisions. This requires discretion, in the models we choose and in the decisions we make. However, more and more asset allocation is being presented as a mathematical science. Somewhere, we seem to have lost the capacity or willingness to make or take responsibility for these discretionary decisions; instead, we rely on systematic, algorithmic-driven models. If one is to increase the importance of discretionary based decisions in asset allocation decisions, what is the place and the value of discretion in the asset allocation modeling process? Is not “discretion” simply another way of saying that judgment and not models must be the deciding factor in a portfolio ’s design and implementation? However, if we permit the introduction of judgment, at what point do we lose the value of the quantitative model?

Asset allocation is not a simple science. There are a number of risks involved in its use. In Chapter 11 we discuss the benefits and costs of various asset allocation approaches from more algorithmic to more discretionary. What is the role of practitioners, academics, and regulators in this discussion? ¹ As shown throughout the book, asset allocation models have logical stopping points, and without the oversight of discretion, unpredictable and unmanaged consequences will occur. While two of the authors of this book are practicing academics, this is an area ...