The final step in the optimization process involves a multivariate model, which ranks the bivariate models to create the optimal portfolio mix. Where MPT ranks linear correlations to determine the efficient frontier, the more complex process used by Smart Portfolios results in the optimal portfolio mix for the targeted time period at a defined risk level.
Regardless of the technique employed, individual investors can benefit from more sophisticated strategies for dealing with downside risk. Whether voluntarily or by necessity, most other industries have modernized and innovated, seeking to maintain a competitive edge. Retail investment management, meanwhile, remains mired in the past, like a Conestoga wagon creeping down a modern superhighway.
Given the availability of PMPT to deliver tools on a workstation for over ten years, why have so few financial services companies adopted it? Regulation, biases, conflicts of interest and entrenched leadership pose significant challenges against implementing the changes desperately needed by the investing public. Could it be that those on the front lines of financial services are ill-equipped for describing and implementing strategies based on advanced math theories? It's unfortunate that the training emphasis for new recruits at financial services firms is focused almost exclusively on the sales process. What are the FPA, NAPFA, IMCA and other industry organizations doing to advance portfolio theory beyond MPT? Let's get ahead of the curve and not let the use of the term "modern" be the next foul cry by the investing public.
The most recent attempt to add value to the retail investor was the ballyhooed launch of lifecycle funds, a predictable disaster. It's time the industry aligned its product development efforts with client realities. Extreme downside risk can be crippling for any investor, particularly so for retirees, and discouraging for early savers. And it happens far more often than Modern Portfolio Theory suggests.