I've had this problem stuck in my head for a while and I'd like some help with it. In David Swensen's Unconventional Success, the argument is made that asset allocation is the best way to get a good return in the long run for the individual, and that no-load mutual funds are the way to go.
If you study Yale's investment portfolio, however, there is a paradox. They publish their allocation annually, but for each category (Absolute Return, Domestic Equities, etc...), they hire outside managers. Now I understand that Yale has far more resources than any of us, so naturally they don't need to buy a S&P ETF to get exposure to domestic equities. Consider this line of reasoning:
- Asset allocation is the best way to get solid returns in the long run.
- For each category, Yale will hire the best hedge funds/investors to manage their money.
- These best investors will produce great returns, which will bolster Yale's portfolio.
- Due to Yale's diversification via asset allocation, they will not be hit too hard even if a single area does poorly, because all the other areas will keep them up.
Ignoring the case where every category does poorly due to something like a global recession, Yale has a terrific strategy for long term growth. My question is this:
They believe that asset allocation is the best way to produce long term growth while mitigating risk. If this is a fact, why aren't the investment managers (IM's) they hire also involved in asset allocation? If an IM's goal is to make money while managing risk (which is the goal of hedge funds), and asset allocation is the best way to do this, then why on earth would an IM concentrate his/her money in a single area?
Assuming that investors select an investment strategy to produce the greatest returns at a manageable level of risk, why don't all investors simply employ asset allocation if it truly is the best way to achieve the goal?