Glassbridge has put out 
an ambitious white paper about the “evolution of asset allocation across the investment management industry,” one that begins with the basics of the Capital Asset Pricing Model and ends with quantitative analysis and crowdsourcing.

The premise is that new strategies, and new ranges of data, are disrupting traditional allocation, and that a step back—a long view—can help asset managers and investors move through this disrupted landscape.

Value Weighting, Equal Weighting

The authors, Jim Kyung-Soo Liew, Robert A. Picard, and Daniel Strauss, start their historical review with the CAPM, built as it was on the idea that if the asset market is to clear, then the market portfolio must be on the minimum variance frontier.

They also acknowledge that CAPM has had trenchant critics, who have disapproved of the unobservable black box nature of this “market portfolio.” Liew, et al., cite Richard Roll for his notorious critique. They observe, much in Roll’s spirit, that in principle the CAPM includes everything, including fintech innovations not conceived in the 1960s, such as cryptocurrencies.

But the key point for the Glassbridge authors is that through subsequent investigation of the CAPM it became clear that the market portfolio was value weighted. The Glassbridge-affiliated authors discuss briefly what they call the canonical example of value weighting in this context, a 60/40 equity/debt split.

There are at least three recognized sorts of weighting. In addition to value weighting there is the simpler “equal weighting” approach. If an investor has 10 assets, or 10 asset classes, in his portfolio, he might simply arrange things so that each constitutes 10% of the whole.

A Third Way: Risk Parity

In contrast to either equal or value weighting, though, there is weighting by risk, generally known as the “risk parity” approach.

Given the 60/40 canonical example named above, for example, it didn’t take traders, investors, or their advisors very long to notice that the amount of risk generated by the equity in a 60/40 portfolio is a good deal more than half, and for that matter a good deal more than 60%. Following the risk-parity approach, the sensible response to this is to borrow, and use the borrowed money to load up on bonds, until the debt side of the portfolio reaches risk parity with the equity side.