Investors need new strategies: Researcher

BOSTON – Last year’s market meltdown proved once and for all that the theory underpinning most investors’ asset allocation decisions needs to be thrown out, a top Fidelity Investments researcher said on Thursday.

Investors ought to re-examine popular diversification strategies based on ‘modern portfolio theory,’ which holds that performance can be enhanced and risk reduced by spreading money over a wide array of asset classes, said Ren Cheng, senior research adviser at Fidelity.’One fundamental mistake our industry is committing is that we love the clean, nice theory too much,’ said Cheng, speaking at a conference in Boston sponsored by Financial Research Corp.For example, investors believe that splitting money among US stocks, corporate bonds and high-yield bonds provides higher returns and lower risk than a less diversified mix. But the three categories now have so much in common that prices of securities often move in concert, Cheng argued. And all three plummeted last year.Even making the most basic distinction between investing in US and non-US developed country stocks may be useless, he said.’Is this just an artificial distinction?’ Cheng asked. ‘Aren’t we in a global equity environment where everything is mashed together?.’Cheng also ridiculed statements by hedge fund managers and other market players that, according to their models, the extreme events of the past two years were so highly unlikely that they were unforeseeable.’Something with less chance of happening than 50 times the age of the universe happened three days in a row, or maybe there is a better explanation?’ Cheng said. ‘Your theory sucks.’Extreme market breaks are more and more likely to happen now that money can flow so easily among different markets all over the world and different countries’ economies are so interconnected, Cheng said. ‘We should see a higher frequency of what we used to call extreme events – it’s here to stay,’ he said.Cheng returned to Fidelity last month as a research adviser after taking a year off. Previously, he was chief investment officer responsible for asset allocation in Fidelity’s ‘Freedom’ line of target date funds.- Nampa-Reuters