The last four years in the market have led some to question whether diversification failed investors in 2008, says Tom Idzorek, the chief investment officer of Morningstar's investment division.

But he took issue with that in his presentation, called "A Non-Normal World: Rethinking Diversification, Risk, Asset Allocation and Modern Portfolio Theory" at the IMCA 2012 New York Consultants Conference, held in New York at the Times Square Marriott Marquis on Monday and Tuesday.

He said that about 25% of U.S. listed stocks lost at least 75% in 2008. However, only four of more than 6,600 open-ended mutual funds tracked by Morningstar lost more than 75% that year. That alone is an advertising pitch for diversification, he said.

In the future, he continued, investors will have to take a new view of risk, a holistic approach that separates a client's risk preferences from his risk capacity. Advisors often do questionnaires asking clients their risk preferences, but that's not necessarily the characteristics they ought to be using, since capacity is different.

When clients are younger, he says, most of their wealth stems from human capital, their ability to earn and save and the skills they bring to the table. When they get older, that human capital diminishes in terms of present value of dollars. As they get closer to retirement, what they have converted into financial capital becomes more important, but they lose the inflation hedge of human capital.

The human capital they have when they are younger, he said, is itself is one undiversified investment, which requires much more diversification and risk be taken in their investment portfolios. And different investors have different risk associated with their human capital. A university professor with tenure, Idzorek said, has human capital on his hands that's more bond-like since it's likely he won't get fired, while an investment banker whose job is often on the line has something more like an equity.

Idzorek also went into an extended presentation explaining how normal distributions are coming more into question as an explanation of returns, and thus how standard deviation is becoming a more questionable way of determining risk and risk capacity. Expounding on the work of his Morningstar colleague Paul Kaplan, he says that the bell-shaped curve for measuring the risk of catastrophic events is flawed.

When you overlay a normally distributed bell curve over the S&P 500 annual distributions from 1926 to 2009, he said, they appear to follow a normal distribution. But it's the details that matter, and years like 2008, he says, "really highlight the flaws in assuming that returns follow the normal distribution"-even as the vast majority of tools used assume that there is a bell shaped curve. When Idzorek and colleagues looked at monthly returns and put them in histogram buckets, then zoomed in on the left-hand tail representing market cataclysms, the histograms suggesting turmoil stacked up are higher than a simple bell shaped curve allow.

"Our risk models are generally understating how often we should expect 2008 type events," he said. "They are occurring ten times more often than our standard tools would suggest."

A log-stable distribution, on the other hand, shows more accurately often how the bad events occur, he said.

In another session, John Brynjolfsson, the managing director at investment management firm Armored Wolf in Aliso Viejo, Calif., and a veteran of Pimco, said his job seeking frequent alpha opportunities for clients in the global economy means focusing on the difference between real and generic asset allocation, which means real quantities denominated for consumption-in other words, adjusted for inflation.

"Our clients, they would all like to make a lot of money, but making a lot of money in an environment like the 1920s Weimer Republic didn't buy anybody a loaf of bread," he said during his presentation, "Global Macro Outlook and Real Asset Allocation." "So making a lot of money by itself isn't the right metric, the real metric is to grow purchasing power."

Brynjolfsson said that we have a three-speed global economy right now, one is Europe and its recessionary blues, another is the muddling United States and then there is the thriving developing world. But almost every country of import in the world, he said, is growing slower than it did in the five years leading up to the 2008 financial crisis. "The risk is of an event on the downside," he said. Globally, he said we might be looking at 3.5% or 4% global GDP growth, but the math is being turned on its ear by developing world growth in places like China that have been growing at 8% while the developed world grows at 1%-2% and loses population.

"Within a few years, the developing world will account for more than 50% of GDP growth," he said. "And for the businesses than I'm in where I'm looking at raw materials and commodities and global currencies, it's the movement of physical goods and materials that are driving the equation. ... The developed world is more focused on intangible products like downloading iTunes." These developing countries will focus more on internal growth as exports shrink.

However, the global growth prospects next year are predicated on three things, he said: that the U.S. will not fall into a recession, that the emerging markets will respond with the strong economic policy tools they've created and that Europe will tackle their credit crisis.

"The third assumption, I'm not going to buy it," Brynjolfsson said. "I don't think the Europeans are going to logically figure out a way to solve their problems because just at a guttural level there is not a union of mind. ... The German people do not want to see a situation where their savings and austerity and prudence are being used to pay for the retirement plans of Southern Europeans. And frankly, southern Europeans don't want to be part of a German federation."

-Eric Rasmussen