Today, I’ll take a different approach. Rather than simply shaking my fist at the sky hoping that will improve returns, I want to focus on this too-common reach for complexity as the solution to investment problems and to suggest that instead we should strive, wherever possible, for simplicity. Or rather for as much simplicity as possible — but no more. Think of it this way: The simplest possible portfolio is just cash, but you can only do that when you are fully funded and have no chance of missing your goals. If you’re not there, you need to get more complicated — adding asset classes as you go, adding active management, adding more complicated or abstruse asset management and asset classes. Each time you’re doing that you should be thinking “Do I need to do this; am I sure I know what I’m doing; do I have the governance in place to do this?”
Now, it’s important to note that complexity has an important role in what we all do. The firm where I work has many highly sophisticated investors as clients, with deep and expert investment staff and the capability to really dig into and understand the implications of complexity in their portfolios. Working with them on that process is an important part of what we and our competitors do. But it’s important to note that being able to understand and manage complexity is different from assuming that complexity will provide investment solutions that will solve every problem when capital markets are unpromising — and that is often the feeling that you can get when you hear the latest investment strategy being described and proposed as the solution to investor challenges.
The important point to remember is that complexity is rarely a benefit in itself and is often precisely the opposite. Complex solutions are harder to understand and the ways they are likely to behave in different circumstances can be hard to model. Complicated solutions can, in fact, solve some investment problems, but investors need to be able to very clearly define the particular problem being solved, and then be able to perform effective analysis to confirm that the proposed solution does in fact solve that problem. An example is adding derivative-based strategies to the portfolio. That can be helpful in a number of ways — helping change the shape of your returns, protecting against downside, adjusting your risk exposure — but you have to be sure you understand the exposures you are putting into the portfolio and that you can measure what success and failure look like.
What complexity tends to be bad at doing is solving the big building block problems of portfolio management.
What are those big building block problems? There are three of them. First, interest rates are …….
Source: https://www.pionline.com/industry-voices/commentary-simplicity-investing-matters