CAPM as an allocation strategy.
Market efficiency was predicated on several falicious ideas, including:
- Everyone can borrow (and lend) at the same rate, indefinitely (i.e. no matter their leverage)
- All information is known instantaneously by all market participants.
- There are no transaction costs.
- Rational behavior.
One conclusion is that the higher the beta, the higher the return, but this has clearly been shown to be violated.
While it is useful for segmenting $\alpha$ and $\beta$ (and for portfolio/strategy evaluation), it simply isn't entirely reliable as a portfolio allocation strategy.
As Fama/French concluded in "The Capital Asset Pricing Model: Theory and Evidence" (2004):
The CAPM, like Markowitz's (1952,
1959) portfolio model on which it is
built, is nevertheless a theoretical
tour de force. We continue to teach
the CAPM as an introduction to the
fundamental concepts of portfolio
theory and asset pricing, to be built
on by more complicated models like
Merton's (1973) ICAPM. But we also
warn students that despite its
seductive simplicity, the CAPM's
empirical problems probably invalidate
its use in applications.
Note that CAPM adds many assumptions to Markowitz's fundamental model to built itself. Therein lies its fallacy because as said above, those are difficult assumptions. Markowitz' model itself is fairly general in that you can inject 'views' of higher returns or greater volatility etc into the basic framework (or not!) and still be quite rooted in reality for mid-long term horizons.