Risks, Not Risk

From David Merkel in Aleph Blog

There is no generic risk.  There are many risks.  Are you getting fair compensation for the risks that you are taking?  If not, invest in other risks, or if there are few risks worth taking, invest in cash, TIPS, or foreign fixed income.

To this end, it is better to think in terms of risk factors rather than some generic formulation of risk.  Ask yourself, am I getting paid to bear this risk?  Look to the risks that offer the best compensation, and avoid those that offer little or negative compensation.

Modern Portfolio Theory has done everyone a gross disservice.  It is not as if we can predict the future, but the use of historical values for average returns, standard deviations, and correlations lead us astray.  These figures are not stable in the intermediate term.  The past is not prologue, and unlike what Sallie Krawcheck said in Barron’s, asset allocation is not a free lunch.  With so many people following strategic asset allocation, assets have separated into two groups, safe and risky.

Any risk reward strategy that is developed by looking backward at historical performance will no longer work well when everyone knows and uses it.  See the Law of Risk and Light Riskviews
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