Few “discoveries” in finance and economics stand the test of time, much less so in the realm of forecasting. One of the rare exceptions is the seminal research by Bates and Granger (“The Combination of Forecasts”), which celebrates its 51st anniversary this year. The paper’s central insight: combining forecasts from multiple methodologies tends to deliver better projections compared with one model’s estimate. Many researchers, along with practicing economists and investment analysts, have extended and retested the Bates and Granger study many times, in various applications, over the decades. It’s no trivial point that the paper’s main finding has weathered the…

(Note: This blog was posted at 2:45 pm on January 30, 2020.) The coronavirus death toll rose to 170 and confirmed cases soared past 7,700, posing a potentially serious threat to the global economy. Pursuing an unproven and hastily developed vaccine in hopes of inoculating your portfolio from effects of the virus may be more harmful than the virus itself. Our long-term prognosis for the markets is a full and complete recovery. “The economic impact [of the coronavirus] will depend very much on the behavior of the illness itself, how fast it spreads, who it affects, and how quickly the…

The popularity of trend-following strategies has surged over the past decade. In the wake of the 2008-2009 financial crisis, a growing number of investors embraced the risk-management attributes of the so-called momentum factor—the tendency of recent returns to persist in the near-term future. (Trend-following and momentum strategies are close cousins; for convenience, we’ll use these terms interchangeably.) Backtests found in a deep pool of academic research appears to document the power of momentum’s advantages over a buy-and-hold strategy or periodic rebalancing to target weights. But for some momentum strategies, results in recent years haven’t lived up to the backtests. As…

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…