Illusions of Precision, Completeness and Control : A Case for Simple, Transparent Portfolios

The Financial Crisis of 2008/2009 increased plan sponsors' desire to control risk — and we are still seeing the unfortunate effects. Many approaches adopted to control risk are illusions of risk control. Of particular concern is how sponsors are misapplying tools designed to monitor portfolios, and instead, are relying on them to build portfolios. Portfolio design and reallocation decisions often are now driven by complex, but often incomplete, measurement tools. The premise of these tools assumes greater detailed structuring and monitoring leads to greater control over the generation of risk-adjusted returns. But is the promise of this approach paying off and are the trade-offs of complexity and lack of transparency worth it?The purpose of this paper is to challenge what I see as an increasingly popular approach to portfolio construction and evaluation that relies on complex, quantitative models. As an alternative, I make a case for simple and transparent portfolios. I will focus as an illustrative example on the misuse of mean- variance optimization and “nine-box” investment models, as well as the elusive search for alpha