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By Paul Kaplan | 05-28-2009 03:51 AM

Modern Portfolio Theory in the Heat of the Meltdown

To effectively use MPT, investors must recognize its limitations and be willing to challenge it, says Russell Investments director of capital markets research Steven Fox.

Paul Kaplan: Hello. I'm Paul Kaplan, and I'm vice president of quantitative research at Morningstar. And here at the Morningstar Investment Conference, we had a session that was called "Can Modern Portfolio Theory Take the Heat of a Meltdown?" And one of our panelists is Steven Fox. Steven is the director of capital market research at Russell Investments.

Thank you, Steve, for coming to the conference and participating in the panel. And maybe you can just briefly describe for us what we talked about in this panel and, from your perspective, what are kind of the key takeaways.

Steven Fox: Well, we vigorously debated the merits of a model-based approach, such as MPT, to deciding how to asset-allocate a portfolio, versus something that incorporated a different view of how an investor might take risk into consideration.

Key takeaways that I would describe from our discussion and debate would be that diversification still matters. It's still a valid principle. Risk/reward trade-off is alive and well in markets. The other takeaway might be that there's room in the stable for non-model-based approaches along with model-based approaches to doing asset allocation. The world is complex, and we need to take into account as much information as we can in our decisions.

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