The Search For True Diversification

Diversification has long been the Holy Grail that animates informed portfolio design. The debate is how to achieve it? The standard prescription: hold a mix of asset classes, perhaps spiced up with strategies that strive to re-engineer the conventional risk-reward relationship inherent in plain-vanilla market betas. On paper this sounds reasonable but the reality is messy, as a recent research note from Two Sigma Advisers reminds. “For many years, investors relied on the assumption that combining different asset classes within a portfolio was an effective way to maximize risk-adjusted returns,” write Geoff Duncombe (the firm’s chief investment officer) and two…

Is Bond Alpha As Good As It Looks?

The case for indexing equity portfolios has been thoroughly established in the financial literature and, more importantly, in real-world results. The merits of indexing with respect to fixed income investing, by contrast, is more of a gray area. A recent study by AQR finds that bond fund managers aren’t generating true alpha, but rather are simply farming the excess returns that come from their willingness to assume greater risk. In simplest terms, investing in equities is straightforward. Corporate stock, for the most part, comes in one format (common stock), and what to pay for it can be boiled down to…

Low Interest Rates Still Look Like The New Normal

The financial crisis that ripped through the global economy in 2008-2009 ended more than a decade ago, but one of its most confounding offspring persists: low (and in some cases negative) interest rates. Some have suggested this phenomenon is largely – if not wholly – due to the Federal Reserve’s truculence in managing monetary policy. If only the central bank would raise interest rates, so the story goes, the price of money would return to the “normal” state of affairs that presided before the Great Recession. If only it were that easy. The Fed sets interest rates, but the influence…

What Do Risk Preferences Reveal For Asset Allocation Decisions? A Lot.

Managing risk is forever at the top of the list for informed investing, but the biggest challenge on this front arises from within. As Pogo famously said, “We have met the enemy and he is us.” So-called behavioral risk comes to mind after reading a recent survey of risk preferences, which reminds that investor perception on risk casts a long shadow on choices for asset allocation and, by extension, portfolio returns. Perhaps the most surprising result is that individual investors tend to think about risk is starkly different terms vs. financial advisors and institutional investors. Not surprisingly, these preferences have…

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