PII: 1057-0810(92)90011-Z


From the Editor 

Investors today are faced with an abundance of investment vehicles and a 

bewildering number of claims made by the vendors of these vehicles. Individuals 

are urged to purchase mutual funds or variable annuities based upon a variety of 

performance measures including alphas, betas, and five and ten year compounded 

annual returns. Some vendors tout investment “systems”, such as dollar cost 

averaging, as best meeting the investor’s needs. 

The four articles in this issue call into question many of these claims. The first 

article, “A Multicriteria Approach to Mutual Fund Selection,” by Kevin Hebner and 

Wade Cook looks beyond a fund’s risk-adjusted rate of return. They suggest a 

multicriteria methodology matches a set of fund attributes to the preferences of the 

individual. These attributes include such things as front and back-end load fees, the 

level of diversification, the quality of service and the standard deviation of the fund’s 

alpha. 

The second article, “Active Asset Allocation Decision of Professional Equity 

Managers,” by Robert Brooks, Haim Levy and Robert Radcliffe, is related in that it 

tells us not to trust a single measure of a managed portfolio’s risk, notably its beta. 

The widely reported time series beta is found to be a poor predictor of a portfolio’s 

current equity risk exposure since active and passive asset allocation will change 

that beta from one quarter to another. They recommend that investors be given the 

fund’s current cross-sectional beta as well since this best describes the market risk 

of the current portfolio. Incidentally, this information is already supplied to the 

sophisticated consultants of large investors such as pension funds. 

The third article is “Long-Run Returns on Stock and Bond Portfolios: Impli- 

cations for Retirement Planning” by Kirt Butler and Dale Domian. Since retirement 

funds are accumulated and disaccumulated over long periods of time, the authors 

look at the effect of time diversification on the choice of asset classes. By resampling 

Ibbotson data they find, for example, that over a 30 year period of accumulation, the 

probability that corporate bonds will outperform common stocks is less than 4 

percent. This type of information is critically important to individuals who are forced 

to make asset allocation decisions about their pensions with little substantive 

guidance. 

V 



Vi FINANCIAL SERVICES REVIEW, 2(l) 1992/1993 

The fourth article “Nobody Gains from Dollar Cost Averaging,” takes on one 
of the most cherished and widely advertised investment techniques recommended 
by retail brokerage firms. Written by John Knight and myself, the article contrasts 
dollar cost averaging with optimal rebalancing and a buy and hold strategy through 
graphical and empirical analysis and numerical simulation. Dollar cost averaging, 
even without including its high transactions costs, turns out worst for investors, but 
perhaps not for its promoters. 

While all of the articles are academically rigorous, they also have immediately 
usable implications. Hopefully they will be used by the better educated financial 
planners as well as by financial product vendors seeking to enlarge their share of an 
increasingly sophisticated market. 

A great deal of additional research needs to be done in the area of individual 
investment. We do not know, for example, the effect of mean reversion on optimal 
portfolio construction for the individual. Nor do we know why so many consumers 
purchase mutual funds and variable annuities with timing services that almost 
consistently underperform the indices. Little has been written about hedging pur- 
chasing power risk in retirement portfolios, particularly for those living on non- 
adjustable defined benefit pension plans. And what about the tradeoffs of adding an 
employer’s stock to your portfolio in a subsidized purchase plan when you are 
already dependent upon that employer for your salary and pension? 

This column will be used to suggest research topics in individual financial 
management. The editors of Financial Services Review are accessible and welcome 
calls to discuss research ideas. 

-Lewis Mandell