Performance Measurement: How to Do It If We Must Assessing our portfolios’ performance is a necessary activity, but by being aware that measurement over shorter time horizons is dominated by noise, we can better resist the natural human instinct to “do something”—typically selling the underperforming investment at exactly the wrong time—if near-term performance falls below expectations.
When Value Goes Global When the value trade goes global, investors are poised to benefit. Evidence from the international equity, bond, currency, and commodity markets indicates that the value premium is a global phenomenon that can offer important portfolio diversification.
Craftsmanship in Smart Beta While somewhat at odds with today’s big-data, warp-speed approach to life and work, thoughtful craftsmanship—the product design and implementation elements that are tangible, measurable, and impactful—can create positive, persistent results in portfolio performance.
Is Manager Selection Worth the Effort for Financial Advisors? The most commonly marketed service by financial advisors is manager selection. We look at the evidence to see if the resources financial advisors are allocating to this endeavor add value to their clients’ and their own bottom lines.
CAPE Fear: Why CAPE Naysayers Are Wrong Beware the consequences of assuming that elevated CAPE ratios are here to stay, but if they are the “new normal,” low future returns are likely to be the “new normal” as well.
Rob Arnott on Bloomberg TV (January 11, 2018)
Winner of the 2018 Bernstein Fabozzi/Jacobs Levy Award for Best Article: King of the Mountain: The Shiller P/E and Macroeconomic Conditions Valuation, always an effective tool for long-term investors, can also be useful for assessing short-term market prospects. The authors demonstrate that conditioning CAPE on current inflation and real yields substantially improves its accuracy in forecasting returns for periods from one month to one year.
Hobbled by Benchmarks Many investment organizations benchmark their funds’ performance against the classic 60/40 mix of domestic stocks and bonds, but this posture limits their ability to earn superior risk-adjusted returns. The authors argue that investors can fully realize the well-established benefits of asset-class diversification only if they are seriously willing to revisit their policy portfolios, investment guidelines, and benchmarks.
Building Portfolios: Diversification without the Heartburn The wisdom of diversifying investor portfolios across a wide range of asset classes is indisputable. But diversifying client portfolios beyond mainstream stocks and bonds comes with challenges, starting with clients’ unfamiliarity with diversifying asset classes and a propensity for clients to regret diversifying when results disappoint.
The Bubble That Never Came (and Other Misconceptions about Treasury Bonds) A 10-year US Treasury note yielding just little above 2% does feel expensive. Yet we should not be misled by appearances. Our research shows that, contrary to common wisdom, Treasury bonds are only moderately overvalued. All in all, bonds are not as unattractive as a simple historical comparison of their yields may suggest.
Pricing Stocks and Bonds A look at a simple, robust framework for estimating long-term asset-class forecasts, and its underlying assumptions, offers insights as to how asset managers can build a portfolio to meet investors’ future financial needs.
Can Momentum Investing Be Saved? Momentum is one of the most compelling factors in theoretical long–short paper portfolios, but live results of momentum strategies fall short of theoretical returns. Thoughtful implementation, a careful sell discipline, and an avoidance of stocks with stale momentum can narrow the gap between paper and live results.
Diversification Strikes Again: Evidence from Global Equity Factors Our research shows that the benefits of international diversification extend to equity factor strategies. Investors can reduce portfolio risk by diversifying into foreign markets. Moreover, unlike for asset classes, diversification benefits have not declined over time. Investors should be brave, and look beyond their borders.
Risk: Preparing Clients for an Uncertain Journey If we think of expected return as the likeliest long-term “destination” of our investment portfolio, we can then think of risk as the uncertainty in the “journey” to that destination. Advisors serve their clients well by helping them understand the many paths that journey can take, and by establishing a plan of action (or inaction!) for when shortfalls inevitably occur.
The Most Dangerous (and Ubiquitous) Shortcut in Financial Planning Starting conditions matter. Today’s investment yields impact future realized returns. But many still rely on past returns to estimate future returns. Our online Asset Allocation Interactive tool gives you the information you need to look ahead, not just back.
The Folly of Hiring Winners and Firing Losers Performance chasing in manager selection is a reliable path to poor results. But by combining factor valuation with past performance, investors gain a richer toolkit for making well-informed allocation decisions among smart beta managers.
Live from Newport Beach. It's Smart Beta! Investors don’t have the luxury of re-takes—investing committed capital is “live.” But all too often smart beta investors must make decisions based on backtests. We point out a few things investors can do to get the benefits they expect.
A Smart Beta for Sustainable Growth We demonstrate a smart beta that produces positive excess returns from sustainably faster growth in EPS. This simple, systematic strategy represents a significant improvement from today’s growth indices that fail to produce faster growth in EPS and have provided negative excess returns.
Cost and Capacity: Comparing Smart Beta Strategies The significant growth in smart beta investing leads to potential alpha erosion when trading volume affects security prices. Our research shows how market impact costs due to rebalancing affect the capacities of popular strategies.
CAPE Fatigue When investors rely on any particular model all the time-and CAPE is often that model-fatigue inevitably sets in. We believe that a better approach for meeting future spending needs is to blend portfolios based on different models of return expectations.
Time Diversification Redux Understanding how a common and simple definition of risk, such as the standard deviation of returns, differs over various time horizons has important implications for investors. We discuss why the relationship between investment horizon and risk matters.
Underweight FANMAG? Chillax! If it seems everyone's portfolios—except yours—are overweight the FANMAG stocks, chillax! We're here to remind you not to forget the long–term value proposition of contra–trading: trimming pricey stocks and rebalancing into unloved stocks, exactly what the RAFI strategies are designed to do.
Which RAFI Index Strategy Is Right for You? RAFI and RAFI Dynamic Multi-Factor have different risk and return characteristics. The choice between the two strategies should be determined by an investor’s objectives and their institutional governance mechanism.
Why Factor Tilts Are Not Smart “Smart Beta” Our analysis of three first-generation smart beta strategies shows factor-replicated portfolios are ineffective substitutes for their smart beta counterparts, exhibiting poorer performance, high turnover, and low capacity.
The Incredible Shrinking Factor Return Managers who favor high factor loadings on market beta, value, or momentum generally do not derive nearly as much incremental return as theoretical factor return histories would suggest, and the culprit appears to be the real-world costs of implementation.
RAFI Multi-Factor RAFI Multi-Factor is a smart beta equity strategy that offers diversified factor exposures through allocations to value, low volatility, quality, momentum, and size.
A Smoother Path to Outperformance with Multi-Factor Smart Beta Investing You can outperform the market with substantially lower relative risk by diversifying across simple smart beta strategies based on a half dozen robust factors. Dynamically rebalancing these factor-based smart betas significantly improves returns.
Will Your Factor Deliver? An Examination of Factor Robustness and Implementation Costs Not every factor profits investors when implemented through a passive strategy. Size and quality show weak robustness, and liquidity-demanding factors, such as illiquidity and momentum, are associated with high trading costs. Investors may be better off accessing these factors through active management rather than indexation. Published in the Financial Analysts Journal by Jason Hsu, Vitali Kalesnik, Noah Beck, and Helge Kostka.
Winner of the 2015 William F. Sharpe Award for ETF/Indexing Paper of the Year: "A Framework for Assessing Factors and Implementing Smart Beta Strategies" Investors might apply advanced techniques of quantitative analysis to discriminate between genuine premium-bearing factors and the spurious products of data-mining—but here’s a three-step heuristic. Published in the Journal of Index Investing by Jason Hsu, Vitali Kalesnik, and Vivek Viswanathan.
Winner of the 2015 Bernstein Fabozzi/Jacobs Levy Award for Outstanding Article: "A Study of Low-Volatility Portfolio Construction Methods" Long-term simulations in U.S., global developed, and emerging markets confirm that low-volatility strategies can potentially access risk-diversifying sources of excess return. However, portfolio construction methods should be sensitive to investibility and valuations. Published in the Journal of Portfolio Management by Jason Hsu, Tzee Chow, Feifei Li, and Li-Lan Kuo.
Winner of the 2012 William F. Sharpe Indexing Achievement Award for Institutional Investor Journals Paper of the Year: "Rebalancing and the Value Effect" Value stocks typically enjoy higher dividends than growth stocks. Growth stocks, on the other hand, typically enjoy faster dividend growth. What most investors miss is that a portfolio of value stocks generates faster growth in dividends than a portfolio of growth stocks. Published in the Journal of Portfolio Management by Rob Arnott and Denis Chaves.
Forecasting Smart Beta and Factors: History Is Worse than Useless Past is NOT prologue. With the proliferation of smart beta and factor strategies, investors should be vigilant to the pitfalls of data mining and performance chasing. Relative valuations can predict the long-term future returns of strategies and factors —not with any short-term precision— but well enough to add material value. Useful forecasting models should furthermore address implementation costs.
How Not to Get Fired with Smart Beta Investing Lengthening the evaluation horizon, combining robust strategies, codifying investment beliefs, and improving communication can strengthen—and prolong—the principal–agent relationship.
Charting the Journey in Smart Beta Historical factor returns—net of changes in valuation levels—are much lower than recent performance suggests. In fact, many of the most popular new factors (some 458 at last count) have succeeded solely because they have become more expensive. This trend matters to investors because rising valuation levels inflate past performance, reduce potential future performance, and amplify the risk of mean reversion to historical valuations.
Rethinking Conventional Wisdom: Why NOT a Value Bias? Not all long-term sources of excess return are treated equally in portfolios, frustrating investors’ ability to meet their financial goals. Asset owners and their agents need to act now to address the primary sources of this disconnect: cognitive bias and principal–agent conflict.
Quest for the Holy Grail: The Fair Value of the Equity Market Macroeconomic volatility is a useful tool for contrarian investors who are seeking fair value in an equity market characterized by continually rising valuations.
Record Low Costs to Trade! Mean reversion is as applicable to trading costs as it is to valuation. Today’s costs to trade are at 56-year historical lows; they are due to rise soon. Now is the time to position your portfolio ahead of expected higher costs to trade and lower equity prices.
Next Season’s Meager Harvest in Commercial Real Estate US commercial property investors reaped high real returns over the last five years, but the climate is changing. Property prices are high, yields are low, and future expected returns portend a scantier harvest over the coming decade.
Systematic Global Macro The alternative factor premia of carry, momentum, and value may be combined to produce an attractive and diversifying source of investment return relative to the low yields and low returns of mainstream stocks and bonds.
(Video) A Smart Beta for Sustainable Growth Chris Brightman, Vitali Kalesnik, and Mark Clements explain why a systematic smart beta strategy that invests in profitable companies with conservative investment can diversify value exposures while also delivering strong positive excess return from sustainably faster growth in EPS.
(Video) Why Factor Tilts Are Not Smart “Smart Beta” We challenge the common view that “smart beta” strategies and factor tilts are the same. In fact, factor-replicated portfolios are poor substitutes for their smart beta counterparts. Performance is poor, turnover is high, and capacity is terrible. Why? Implementation details matter—both for performance and for trading costs.
Alice in Factorland and the Incredible Shrinking Factor Return Research by Rob Arnott, Vitali Kalesnik, and Lillian Wu shows that factor-tilt strategies suffer from substantial return slippage (vs. factor long–short paper portfolios) due to the real-world costs of implementation.
Asset Allocation Interactive Navigate long-term forecasts for over 130 assets and model portfolios
Smart Beta Interactive Explore expected returns and valuations for smart beta and factor strategies
RAFI Strategies
RAFI™ Strategies RAFI strategies aim to generate excess returns versus the market benchmark through a systematic, contrarian rebalancing approach.
All Asset
All Asset All Asset strategies are global tactical asset allocation (GTAA) solutions that aim to deliver attractive real returns, equity diversification, and inflation protection via tactical long-only exposures.
RAE RAE systematic active equity strategies seek to generate superior risk-adjusted returns.
Systematic Alternative Risk Premia
Systematic Alternative Risk Premia The Systematic Alternative Risk Premia strategy aims to deliver uncorrelated absolute returns through leveraged long–short exposures to liquid derivatives contracts.
FTSE World Investment Forum, Rob Arnott Utah: May 20-23, 2018
Financial Investigator, Vitali Kalesnik Amsterdam: May 29, 2018
Inside ETFs Smart Beta, Rob Arnott NYC: June 6, 2018
Rob Arnott on Bloomberg TV (August 25, 2017)
John West at the Morningstar Conference (April 27, 2017)
Rob Arnott on Bloomberg TV (April 10, 2017)
Chris Brightman on Bloomberg TV (March 28, 2017)