Research

Successful market timing is a tantalizing holy grail for investors, especially when there seems to be persuasive evidence that simple valuation measures have the ability to predict subsequent market performance.

But, as both researchers and investors have discovered, outperforming a passive buy-and-hold approach is harder than it might seem. Is market timing an easy source of added value or a sin to be avoided? In this article we explore the difference between the encouraging in-sample long-horizon evidence and directionally right but weak and disappointing out-of-sample performance. We propose an interpretation that offers a practi…

There are some misguided notions regarding the ongoing debate about whether investors should attempt to time the market. We call these market timing myths.

Myth #1 is that you should not try to time the market because if you miss even a few of the best periods all the long-term returns from being in the market go away. In other words, do not practice market timing because it is very dangerous.

Myth #2 is that you should not try to time the market because even an investor with perfectly terrible market timing (defined as investing a set amount every year at the worst possible time) does almost as well over the long-term as s…

Some systematic strategies that were profitable years ago lost their edge as investors piled in and technology advanced. In light of the current drawdown, some investors are asking whether markets have fundamentally changed and what this might mean for time series trend following.

Using six lines of investigation, including historical and simulated distributions, crowding, opportunity costs and the current environment, among others, the evidence suggests that trends have been persistent and the recent negative performance is not unexpected at some point as part of a long track record.

We continue to believe that the best appr…

In the late stages of long bull markets a popular question arises: What steps can an investor take to mitigate the impact of the inevitable large equity correction? Hedging equity portfolios is notoriously difficult and expensive. In this article the authors analyze the performance of different tools that investors could deploy.

For example, continuously holding short-dated S&P 500 put options is the most reliable defensive method but also the most costly strategy. Holding safe-haven US Treasury bonds produces a positive carry bur may be an unreliable crisis-hedge strategy because the post-2000 negative bond-equity correaltion is a …

In this paper we present a novel approach to investing across equity, bond, currency and commodity markets. “Economic trend” capitalizes on the tendency for new information to have a persistent impact on asset prices by positioning in each market on the basis of trends in macroeconomic fundamentals.

This hypothetical strategy has realized consistently attractive risk-adjusted returns over a 50+ year sample, and performance is pervasive across both markets and measures. It exhibits low correlation to traditional risk premia on average and tends to perform exceptionally well during drawdown periods for traditional asset classes. …

The risk parity (RP) approach to asset allocation has gained in popularity among practitioners. RP investing starts with the observation that traditional asset allocations, such as the market portfolio or the 60/40 portfolio of stocks/bonds, are not well diversified when viewed from the perspective of how each asset class contributes to the overall risk of the portfolio. Because stocks are so much more volatile than bonds, movement in the stock market dominates the risk in the market portfolio.

RP seeks take advantage of this by investing more money in low-risk assets than in high-risk assets, and leveraging the resulting portfolio …

This issue of Alternative Thinking shows how different investments performed amid the worst quarters for stock and bond markets in recent decades. It concludes that certain long/short strategies have been not only market-neutral in the long run, but also during these tail events — suggesting a valuable role over the long-term, and when it really counts.

It also documents strong complementary behavior from two strange bedfellows — private equity and trend following — which have each tended to do well when the other has fared poorly.

We provide new out-of-sample evidence on trend-following investing by studying its performance for 82 securities not previously examined and 16 long-short equity factors. Specifically, we study the performance of time series momentum for emerging market equity index futures, fixed income swaps, emerging market currencies, exotic commodity futures, credit default swap indices, volatility futures, and long-short equity factors.

We find that time series momentum has worked across these asset classes and across several trend horizons. We examine the co-movement of trends across asset classes and factors, the performance during differen…

At the heart of risk parity, there is risk management.

Risk parity’s core benefit — improved portfolio diversification — ultimately is a product of how well risk is assessed and managed. For investment managers, the practical considerations are important.

Risk parity strategies share two common elements: (1) balanced risk exposures, which usually mean less capital exposure to stocks than traditional portfolios (and more exposure to everything else); and (2) the use of leverage to scale the portfolio risk to about the level of traditional portfolios.

As an investment style, trend following has existed for a very long time. Some 200 years ago, the classical economist David Ricardo’s imperative to “cut short your losses” and “let your profits run on” suggests an attention to trends. Early in the last century, the legendary trader Jesse Livermore stated explicitly that the “big money was not in the individual fluctuations but in ... sizing up the entire market and its trend.”

The most basic trend-following strategy is time series momentum — going long markets with recent positive returns and shorting those with recent negative returns. Time series momentum has been …

The role of leverage in risk parity is often misunderstood. All else equal, more leverage increases both risk and expected return. But all else is not equal here. The willingness to use modest leverage allows a risk parity investor to build a more diversified, more balanced, higher-return-for-the-risk-taken portfolio. In our view, this more than compensates risk parity investors for the necessity of employing some leverage. Let’s first step back and consider the basics.

We believe that to be called a risk parity strategy there are two crucial ingredients:
- Asset allocation must be balanced by risk, not by dollars.
- I…

The outperformance of Risk Parity strategies during the recent credit crisis has provided evidence of the benefits of a truly diversified portfolio. Traditional diversification focuses on dollar allocation; but because equities have disproportionate risk, a traditional portfolio’s overall risk is often dominated by its equity portion. Risk Parity diversification focuses on risk allocation.

We find that by making significant investments in non-equity asset classes, investors can achieve true diversification – and expect more consistent performance across the spectrum of potential economic environments.