MPT’s Achilles heel, or at least one of them..

It is impossible to find a structure without strengths and weaknesses, or “relatives” between the two.  One of the key weaknesses of MPT is that the return assumptions used to define asset allocation are the same as those used to determine safe withdrawal rates.

Why is this a problem?

Well, when you are allocating to assets within an MVO structure you are actually emphasising the price and risk relatives, not necessarily the absolutes, at least in MPT.  When you are determining safe withdrawals you should be determining the absolutes and not the price relatives.

If you focus on risks to withdrawals you have to depress return expectations and emphasise downside risks to asset classes.  This can compress the relative returns between asset classes used to derive optimum asset allocations from an MVO structure.  In other words, if you are and Monte Carlo…ing, then you cannot do both – you are either allocating to relative return, or assessing risks to absolute return and not relative return.

I am not going to explain further, but let you the subject solve the riddle!   It is important that wealth management systems manage both relationships. 

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