Most financial planners and personal portfolio managers are questioning their basic assumption of asset allocation. In the year 2008 asset allocation failed. This of course is their conclusion based on a set of data. Data is accurate but the conclusion seems to be a little flawed.

In the years from 2002 to 2007 (when Mr. Risk was on leave) we took all sets of data and came to fantastic conclusions. We concluded that when the dollar gets weak commodity will go up. We concluded that Asia was de-coupled from US. We concluded that a weak dollar will see strong commodities like oil – without worrying about high oil prices derailing Asian economies. We thought keeping money in debt was for sissies. After all men invested in equities.

We forgot that when returns are climaxing, risk is lurking pretty close. We assumed that equity returns of 30% p.a. is ours by right. We forgot ‘Regression to the Mean’. We forgot that when standard deviation is high, arithmetic mean (arithmetic average) is a poor indicator regarding data reliability. If we had taken annual returns and seen the mean and median also we may have had better conclusion. Collectively we forgot ‘Statistics 101’. It reminds me of a Sindhi saying “When God wants you to have trouble, he takes away your brain”. Well He did it for the whole world perhaps!

What exactly happened in 2008? Well practically all investment categories moved in tandem with the S&P 500 Index. The index itself lost 37% in 2008—and everything else went down with it: the MSCI index of Europe, Asia and Australia tumbled 45%, the MSCI emerging markets index lost 55%, REITS gave up 37%, high-yield bonds lost 26% and commodities fell 37%. Only people with a portfolio of just put options would have made money!

Money managers need to treat U.S., emerging markets and international share markets as one in the same. They have to treat commodities as more closely aligned to shares than to inflation. When a commodity company cannot raise money in the equity market to repay its debt obligation, does it matter that you are invested in the commodity, the debt of the company or in the commodity in which it deals?

I cannot agree more with Warren Buffet when he says “Risk comes from doing something that you do not understand”. My life is really risky!!