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Active allocation for passive investors

In a nutshell

This book contains many valuable insights for when you want to boost the effectiveness of your digital investment process. Andrew Lo is an expert in financial engineering, and he particularly masters behavioral finance. He is also the principal investigator at MIT’s lab on artificial intelligence. In his book, he’s demonstrating his expertise by showing us how a marriage of financial content with technology looks and why it makes a difference.

What’s going on here?

Passive investment has long been associated with a buy-and-hold position in a static portfolio. The portfolio holds asset classes such as shares, bonds, and cash in a fixed proportion that aligns with the investor’s long-term balance of risk and reward. Once the portfolio’s composition is defined, the investor is invited to face the future. Rebalances are expected only to correct for asset class performance differences and restore initial portfolio weights.

Why you should care

Well, for one thing: changing market conditions might make the investor re-consider. Lo acknowledges that we are indeed all dead in the long run but warns us to make sure the short term doesn’t kill our clients first.

The long-term view might motivate the initial decision to invest, but investors need to reconfirm every day. Keeping the investor on board might require active management rather than a static, emotionless allocation.

What does this mean?

Behavioral finance allows to model an investor’s emotions, and technology enables to instantly and frictionlessly implement it. Of course, if market conditions change, you should not expect the investor to adapt. However, the investor rightfully expects his/her portfolio to adapt!

The active management is automatic and model-based, molded to the investor’s personality.

Adaptive Markets: Financial Evolution at the Speed of Thought
Andrew W. Lo
Reviewed by:
Jurgen Vandenbroucke

Active management is required to grow passive investors

Andrew Lo
Andrew W. Lo

Andrew Lo is a professor of finance at the MIT Sloan School of Management, the director of MIT’s Laboratory for Financial Engineering, a principal investigator at MIT’s Computer Science and Artificial Intelligence Laboratory, an affiliated faculty of the MIT Department of Electrical Engineering and Computer Science, an external faculty member of the Santa Fe Institute, and a research associate of the National Bureau of Economic Research.

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