Adaptive Portfolios and the Power of Diversification

Abstract

The article gives a qualitative description of an advisory or discretionary investment process that manages the emotional aspect of investing. Portfolios are adaptive, meaning they automatically adjust their allocation in response to changing market conditions. The adjustments are model-based and transparent, and align in terms of frequency and magnitude with the investor’s emotionality. The process looks beyond the risk-focused paradigm in relation to investor profiling, product positioning, and portfolio construction. First, investor profiles distinguish between the attitude toward risk and the attitude toward loss. Second, products differentiate in terms of variance and in terms of skewness. Finally, adaptive portfolios represent a client-centric combination of products that lifts the power of diversification to a higher level and ultimately contributes to long-term buy-and-hold investor behavior.

TOPICS: Wealth management, portfolio construction, statistical methods