In an interview with WealthTrack’s Consuelo Mack, hedge fund manager, author, and M.I.T. professor Andrew Lo says that the financial crisis has shown that a new type of diversification is needed, that buy-and-hold investing is an incomplete approach, and that using a long-only approach puts individual investors at a significant disadvantage.
Lo, who also heads M.I.T.’s laboratory for financial engineering, says buy-and-hold investing is “not necessarily wrong, but it’s incomplete.” Back in 1970s and 80s and 90s, the market had its ups and downs, but overall there was a level amount of risk and a reasonable risk premium, so returns were good. “In order for us to get that kind of return going forward, the long run may now actually be 50, 60, 70 years, not 10 or 20,” he says. “And so, the fact that financial markets have experienced such a significant dislocation really requires us to rethink that paradigm, and think, again, more broadly of not just stocks for the long run but perhaps a combination of other asset classes for the long run.”
Among those other asset classes, he says, are commodities, currencies, Treasury Inflation-Protected Securities, and real estate.
Lo, a major student of investor psychology, also notes that while the recent crisis was severe, the underlying drivers were the same. Human psychology and free enterprise naturally combine to produce financial crises, he says, and as we understand more about that phenomenon, we can better detect warning signs and plan for the crises.
Lo also discusses why he thinks skittish investors need to get back in the saddle; why he thinks another bubble is bound to form; and why he thinks funds like his new fund, which aims to track the performance of a hedge fund in terms of diversification and long/short approach, could become the new market indexes.