Adaptive Asset Allocation

Adaptive Asset Allocation is a no-nonsense how-to guide for dynamic portfolio management. Written by the team behind Gestaltu.com, this book walks you through a uniquely objective and unbiased investment philosophy and provides clear guidelines for execution. From foundational concepts and timing to forecasting and portfolio optimization, this book shares insightful perspective on portfolio adaptation that can improve any investment strategy. Accessible explanations of both classical and contemporary research support the methodologies presented, bolstered by the authors' own capstone case study showing the direct impact of this approach on the individual investor.

Financial advisors are competing in an increasingly commoditized environment, with the added burden of two substantial bear markets in the last 15 years. This book presents a framework that addresses the major challenges both advisors and investors face, emphasizing the importance of an agile, globally-diversified portfolio.

• Drill down to the most important concepts in wealth management
• Optimize portfolio performance with careful timing of savings and withdrawals
• Forecast returns 80% more accurately than assuming long-term averages
• Adopt an investment framework for stability, growth, and maximum income

An optimized portfolio must be structured in a way that allows quick response to changes in asset class risks and relationships, and the flexibility to continually adapt to market changes. To execute such an ambitious strategy, it is essential to have a strong grasp of foundational wealth management concepts, a reliable system of forecasting, and a clear understanding of the merits of individual investment methods. Adaptive Asset Allocation provides critical background information alongside a streamlined framework for improving portfolio performance.

Acknowledgments xi

PART I THE PHILOSOPHY OF SUCCESSFUL INVESTING 1

CHAPTER 1 The Most Important Concepts in Wealth Management 5

CHAPTER 2 The Narrative Is Reality 11

CHAPTER 3 Tightly Grouped Arrows Nowhere Near the Bull’s-eye 15

CHAPTER 4 What Is Gestalt? 19

CHAPTER 5 Measuring the Relative Value of Portfolios 23

CHAPTER 6 The Whole Is Greater than the Sum of Its Parts 27

CHAPTER 7 Our Process Is a Financial Gestalt 29

PART II SAVING AND WITHDRAWING FROM PORTFOLIOS 31

CHAPTER 8 Beware of Those Pesky “Volatility Gremlins” 33

CHAPTER 9 It’s Not Just the Destination, It’s Also the Journey 37

CHAPTER 10 In a Perfect World 39

CHAPTER 11 Home on the Range 41

CHAPTER 12 Timing Is Everything 43

CHAPTER 13 Longevity Risk 47

CHAPTER 14 Plan for the Worst, Hope for the Best 49

CHAPTER 15 Sequence of Returns for Savers 53

CHAPTER 16 Individual Rate of Return for Savers 57

CHAPTER 17 Sequence of Returns for Retirees 59

CHAPTER 18 Do You Feel Lucky? 63

PART III CURRENT HIGH VALUATIONS MEAN LOWER FUTURE RETURNS 65

CHAPTER 19 A Simple Model to Forecast Equity Market Returns 67

CHAPTER 20 Implied Future Returns over the Next 20 Years 73

CHAPTER 21 How Do We Do It? 75

CHAPTER 22 Forecasts 80 Percent More Accurate than Always Assuming Long-Term Averages 81

CHAPTER 23 Roller Coasters Are for Amusement Parks 83

CHAPTER 24 The Last Five Years Have Been a Triumph for the Ostriches 87

PART IV AN INVESTMENT FRAMEWORK FOR STABILITY, GROWTH, AND MAXIMUM INCOME 89

CHAPTER 25 A Word about Asset Allocation 91

CHAPTER 26 The Optimization Machine 93

CHAPTER 27 Garbage In, Garbage Out 95

CHAPTER 28 All We Know Is That We Know Nothing 103

CHAPTER 29 If We Know How Assets Should Behave 107

CHAPTER 30 A Structurally Diverse Investment Universe 119

CHAPTER 31 If We Can Estimate Volatility 121

CHAPTER 32 If We Can Estimate Volatility and Correlation 125

CHAPTER 33 If We Can Estimate Volatility, Correlations, and Returns 129

CHAPTER 34 Summary of the Optimization Machine 133

CHAPTER 35 Building to Adaptive Asset Allocation 135

CHAPTER 36 Integration of Adaptive Asset Allocation 141

PART V WHY YOU SHOULD TRUST THE RESEARCH 145

CHAPTER 37 The Usefulness and Uselessness of Backtests 147

CHAPTER 38 Tactical Alpha and the Quantitative Case for Active Asset Allocation 155

CHAPTER 39 Sensitivity of Safe Withdrawal Rates to Longevity, Market, and Failure Risk Preferences with Implications for Asset Allocation 181

CHAPTER 40 Winning by Not Losing. Or, Bootstrapping to Estimate Risk 203

Final Thoughts 207

Bibliography 209

Index 213

ADAM BUTLER, CFA, is CEO of ReSolve Asset Management, a firm that specializes in ETF managed portfolio solutions for global asset allocation. Adam has over twelve years of experience in investment management, and is primarily responsible for investment research and asset allocation. He is also the lead author for the GestaltU blog.

MICHAEL PHILBRICK, CIM^®, is President of ReSolve Asset Management. He has over twenty years of experience in investment management, contributes to ReSolve’s blogs and research, and is responsible for investment decisions, coaching, and strategic leadership.

RODRIGO GORDILLO, CIM^®, is Managing Partner of ReSolve Asset Management. He has ten years of experience in investment management, contributes to ReSolve’s blogs and research, and is responsible for investment decisions and business development.

If you’re looking for cozy validation of traditional investment beliefs, go ahead and put this book back on the shelf. If instead, you’re looking for a book that challenges widely held investment dogma with a mountain of evidence drawn from historical data and the most respected academic research, this book is for you.

The first hurdle most investors must overcome is their own cognitive wiring. As humans, we are built to thrive in a deterministic world, guided from day to day by our own experience and the signals we get from those around us. But modern markets turn our own instincts against us with randomness, extreme emotions, and the madness of crowds. Learn how to overcome these obstacles with confidence and discipline using a proven, first-of-its-kind systematic approach to investment management.

Adaptive Asset Allocation doesn’t pull any punches; the authors lay out a compelling case for alternative investment methods with the ability to generate returns through even the toughest economic conditions. Essentially, Adaptive Asset Allocation aims to arm both advisors and individual investors with the most powerful tools to smoothly and confidently achieve their financial goals.

Part self-help book, part retirement planning tool, and part advanced investment course, Adaptive Asset Allocation merges practical techniques from many areas of psychology and finance into a practical guide for successful investing.

The authors let the evidence do the talking as they show you how to navigate your investments, and your emotions, across wide ranging market environments, using proven techniques rooted in the most contemporary academic research.