The second supportive development relates to a recent breakthrough in investment technology that greatly simplifies the process of identifying client risk/return preferences and objectives and designing optimal asset allocations to meet them. It also offers a simple test for determining when rebalancing is required. This new technology, known as "resampled efficiency," has been patented by Richard and Robert Michaud of New Frontier Advisors, a Boston-based firm. It increases the probability of maintaining or even increasing a portfolio's returns while reducing its costs. The technology employs simulation techniques to identify a "true" efficient frontier and to avoid the singular asset allocation solutions found in classical mean-variance optimization methods. It is particularly useful in designing purely ETF portfolios that achieve higher returns at specified risk levels while reducing rebalancing costs.
Harry Markowitz, the economist who won a Nobel Prize for his contribution to modern portfolio theory, recently tested resampled efficient optimization and classical mean-variance methods and published his findings in the Journal of Investing in January. He found that resampled efficient optimization methods produce more diversified and stable portfolios with statistically significant higher returns in ten out of ten cases.
Lastly, recent scandals concerning late trading in some mutual funds has made investors aware that certain individuals were allowed to benefit from knowledge of price changes in some securities to the detriment of the funds' shareholders. The vast majority of investors were unaware that such activities were possible, much less taking place. Many investors and regulators alike are outraged at the privileged treatment accorded those individuals, with some believing the offending mutual funds did not take adequate measures to prevent those abuses.
ETFs are not vulnerable to the same late trading activities because only authorized participants can make transfers into and out of an ETF, and this must be done during trading hours. Also, an independent distributor authenticates their trades. Investors wishing to avoid prospective losses due to late trading in mutual funds by unscrupulous individuals are, therefore, advised to confine their investments to ETFs.
C. Michael Carty is founder of New Millennium Advisors, an investment advisory firm in New York City that manages pension plans and individual accounts and often utilizes ETFs. He can be reached at [email protected].