In the English speaking world, we all use keyboards known as QWERTY. However, this well-known keyboard is not optimal. When you prepare to type, your hands rest on the second row of letters known as the home row. Now, you might be forgiven for thinking that the most frequently used letters would appear in this row in order to minimize travel of the fi ngers. However, this isn’t the case. In fact, only 32% of strokes are on the second row, while 52% of strokes are on the upper row. Other such quirks include two of the least used letters in the English language, J and K, positioned on the home row. And this is only the start of a long list of ineffi ciencies with this keyboard.1
So, why do we still use the QWERTY keyboard? The answer lies in historical inertia. QWERTY was originally designed in 1874. It was built to solve a specifi c technological problem with early typewriters: when keys were struck in rapid succession, the hammers that hit the ink ribbon would often jam together. The QWERTY layout was designed specifi cally to slow typists down. Letters that frequently occurred close together in words were spaced irregularly on the keyboard, causing the typist to pause, thus reducing the likelihood of jamming hammers.
So, due largely to technological limits, the fi rst commercially produced typewriters were manufactured with the QWERTY keyboard. Users became adept with QWERTY, and this comfort level acted as a barrier to change. This barrier created enormous inertia such that the majority of us use QWERTY today, despite the fact that more effi cient keyboard layouts are
available.
I maintain that policy benchmarks are the QWERTY of the investment world. They are effectively an accident of history, and if you were starting afresh today, you probably would not come up with a policy benchmark.
It often strikes me that questions surrounding investment are rarely answered from an investment perspective. For instance, when discussing the death of policy portfolios, one of the questions I encounter most often is, “So, how should we measure you?” It appears that many investors prefer measurement precision over investment returns.
In this paper, I argue that policy portfolios and various successors (such as risk parity and life-cycle/glide-path funds) are deeply fl awed from an investment perspective. In particular, two common failings they share are a mismeasurement of risk and an indifference to valuation. I conclude that a strategic asset allocation that alters the asset mix based upon the opportunity set offered by Mr. Market makes far more sense from an investment perspective. (In modern parlance, this translates as a benchmark-free, real return focus.)
To read the full report: STRATEGIC ASSET
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