Likewise, most advisors think building portfolios means bringing together a collection of star performers rather than building a team. This is not a good idea. On any given day, if you pick a group of best-of-breed equity managers to fill out your asset allocation pie, they are likely to have similar characteristics. When these traits cycle out of favor, your managers are likely to underperform together.
At the conceptual level, the answer to this problem is simple. You have to consider how managers may perform together in the future when you put them together in a portfolio. On a practical level, this is easier said than done.
We have developed a computer program that can consider literally millions of possible combinations of managers until it finds the one we think will be the best in the future. In essence, it is a super-duper manager blender that helps us develop the best team, not the best collection of managers. Even if you do not have a tool like ours to work with, you should give serious thought to how the managers you combine in portfolios will complement one another and work together as a team.
Modern portfolio theory is far from dead, but we must recognize that it is a tool, not an answer. If we want the tool to give us good answers, we must continue to improve our inputs and the way we use the information the theory gives us.
Scott A. MacKillop is the president of Frontier Asset Management, a firm that constructs and manages portfolios for financial advisors and their clients. He is a 36-year veteran of the financial services industry. He can be contacted at [email protected].