Problems with the Traditional Allocation Model

I think one of the most important points that the traditional asset allocation model is, is so antiquated that it's broke and unfortunately it's the same model that's being taught in business schools today that was taught thirty years ago and it doesn't work. It was designed for a very definite group of assets, primarily US stocks, US bonds and cash; we now live in a world obviously with a multitude of asset classes if you can call them that. Some investment strategies can't even be really labeled asset classes, they're really just discounted cash flows that you’re capturing within your portfolio and so the whole process by it's very nature must be a whole lot more flexible today and the idea of using the traditional cap-m model and looking at correlations, standard deviations, and projected returns just doesn't work. So it's become a whole lot less science and a whole lot more art... you know, the whole hedge fund model, and by that I know that hedge funds is an extremely broad asset class, but I'm going to really focus on long/short equity for the purpose of this discussion and long/short equity in the hedge fund context was a great strategy for so long. Why? Because it broke away from the traditional model that said ever asset manager has to fit within a box and in order to get a mandate you had to be a small cap value manager or large cap growth manager and you had maybe, a pool of talent within, within an asset management firm structure that was so confined that it really couldn't do the job and what the hedge fund structure did was break away all those constraints and allow people to fish in a pond that was so much bigger, actually, it was more like an ocean rather than a pond but they were able to generate great returns. Unfortunately, what happened people became so bullish on equity, particularly US equities in the 1990s, it became blinded by the need for diversification and when the fallout of 2000 through 2002 came in the markets, everyone panicked and wanted to get the type of diversification that they thought they could get from many of these hedge fund strategies because as we know looking back, it was many of these long/short equity strategies that were either down considerably less the market as a whole or were flat or even in some cases, made money and everyone wanted to be a part of that. And so people really disregarded these and it's interesting because a lot of the pension funds, the state pension funds as institutional investors were kind of, I wouldn't say late in the game, but the not-for-profit endowment university endowment and foundation community really had the lead in terms of investing in hedge funds starting in the early 1990s and in some cases going back before that. Pension funds said, well once we get in, these fee structures are going to come down because it will be institutionalized. Well basic economics tells you, if you want more of something and there's less of it around and the demand keeps going up, the fees aren't going to come down. The bottom line is people were willing to pay very, very high fees for what they thought was downside protection in a meltdown scenario and for the first time, we're seeing in a big way this summer, that it didn't work and I think it's going to have a major impact on how people think about allocating and what types of fees they're willing to pay going forward.