Dear Wilfred, I attended an investment talk. The speaker presented a product X which employed an automated long/short strategy using futures. From the track record, the correlation of this product with traditional asset classes like bonds and equities were low. Such a product looked very attractive to me because it reduces the risk of the portfolio and can even increase the overall return. I would like to buy this product from you. – Regards P.

Dear P,

What you saw in the presentation is a process call mean variance optimization (MVO) in which a few asset classes are put together weighted into certain percentage. The weights are determined in such a way as to give you high average return at low standard deviation (or risk). All this assumes that correlation between asset classes do not change. However life is always not predictable and the truth is that correlation does change between asset classes over time. If you follow the MVO asset allocation and buy this product, you are actually implementing a portfolio that has gained the highest return (lowest risk). What this means is that you are likely to suffer a heavy lost. If you don’t really understand what this means, here is a simple advice: Historical return is never indicative of the future. Moreover, what has make lots of money previously is almost certain to make you lose lots of money. Stick with simple products instead.

Wilfred