One thing we’ve learned from the Covid-19 crisis is that there can be a conflict between resilience and optimisation. If, for example, the NHS had had lots of spare beds, ventilators and PPE equipment before the pandemic began it would have been more resilient and better able to cope with the crisis. But this would at the time have appeared sub-optimal, as these resources would have been wasted for months.
Investors face the same trade-off. Apparently optimal portfolios aren’t always resilient and can even collapse when hit by shocks.
For example, the hedge fund Long-Term Capital Management (LTCM) ran what looked like an optimal portfolio in the mid-1990s. It shorted liquid Treasury bonds and bought less liquid ones because past data showed that this made good returns with little risk. But then in 1998 the Russian government defaulted on its debt, which triggered huge demand for liquid bonds and hence big losses for those who had shorted them.