Picerno, Dynamic Asset Allocation

There is no thornier problem for the investor than portfolio design and management. James Picerno, a financial journalist, tackles this problem in Dynamic Asset Allocation: Modern Portfolio Theory Updated for the Smart Investor (Bloomberg Press, 2010). He surveys the background and evolution of modern portfolio theory, analyzes the efficient market hypothesis, studies alternative rebalancing methodologies, and assesses tactical asset allocation. As he says more than once, there is no silver bullet, but Picerno offers the investor some guidelines.

For many investors who have learned the lessons of diversification asset allocation involves nothing more than combining three or four asset classes (choosing from, for instance, stocks, bonds, commodities, real estate, and cash) in ratios determined by the investor’s age or risk tolerance and rebalancing once every year or so. There’s nothing wrong with this strategy; it imposes discipline on the investor, tends to smooth out the ride, and can be tax efficient.

Picerno, however, suggests that the investor need not be purely reactive but can also look ahead using tactical asset allocation. As anybody who has tried this knows, it’s hard to peer into the future. But there are tools at the disposal of the “smart investor,” among them dividend yield, P/E ratios, price momentum, volatility, and correlation.

Is tactical asset allocation a viable portfolio management strategy for everyone? Picerno answers with an unequivocal “no.” He views TAA as essentially a mean-reverting, buy low sell high strategy; the investors most likely to embrace TAA are those who focus on the long term and assume that “prospective return varies inversely with recent market trends.” (p. 181) As Robert Arnott wrote, “tactical asset allocation potentially enhances long-term returns without increasing portfolio risk, but at a cost of lower comfort, hence lower utility, for many investors.” TAA is for those who can buy when there’s blood in the streets and sell when everyone else is drunk with investing success.

Personally I think Picerno frames TAA too narrowly; it is not the sole property of the value investor. For instance, anyone with a tax-free account such as a Roth IRA who pays low commissions can easily pursue a range of strategies, some of which might involve holding periods of days or weeks, not months or years. Yes, it requires more active management, but it doesn’t mean giving up one’s day job. Sometimes it even beats buy and hold!

In this book Picerno offers a little something for everyone. He summarizes an array of financial literature without becoming technical or mathematical, he outlines ways to tweak common portfolio management strategies, he points the way toward the future of asset allocation, and throughout he respects the personality and risk profile of the individual investor—hence the need for customized solutions.