Research Affiliates

While inflation dipping below 3% has been welcome news for investors, it's still early to claim that inflation has been reined in. Our simple analysis shows that inflation rising in the later half of 2023 would not be surprising. Additionally, history shows that inflation is not always transitory, and it can take many years to bring inflation under control.

The Fed’s refusal to pause rates through the first five months of 2023 raises the odds of a hard landing. The magnitude of the yield-curve inversion has increased the risk inherent in the US banking and financial systems. The impending recession is unnecessary and self-inflicted.

RAFI™, the genesis of the term smart beta, has produced consistently strong performance over the last 35 years when measured against a style-equivalent, or value, benchmark. It’s time to take a fresh look at an extraordinary idea!

RAFI Fundamental Index strategies are poised to outperform... Currently trading at low valuation levels, RAFI Fundamental Index strategies have a history of outperformance during periods of heightened inflation, bear markets, and recessions.

As we start 2023, the US dollar has pulled back 12% from its high in September 2022, but remains 25% elevated from its lows at the start of the last decade. The US dollar’s long march upward may be ending, squeezed by an expected shrinking interest rate differential with other developed nations that must keep hiking rates to fight inflation. The Fed, however, as US inflation appears to moderate, can also moderate its rate hikes. Our research shows that in a weakening dollar environment, unhedged foreign stocks and bonds should outperform.

Five years after the publication of our controversial 2016 paper “How Can ‘Smart Beta’ Go Horribly Wrong?” we analyze how the factors did perform from June 2017 through June 2022. Most fell far short of expectations. Today, we are bullish for the mirror image of the reasons we were cautious in 2016 and 2017. Of the 19 factors we study, 11 are now trading in the cheapest quintile of their historical relative valuation. Now is a promising time to embrace multi-factor investing.

We show analytically and empirically that the long–short investor is more likely to benefit from hedging out sector bets, whereas the long-only investor is more likely to benefit from investing in the factor as it stands. 

Across 14 developed-economy countries over the past half-century, the authors analyze the behavior of inflation once a country’s inflation rate surges past various thresholds and study how long a burst of inflation typically lingers. If history is a guide, inflation can take far longer to return to normal levels than most people realize. Transitory inflation is certainly possible, but it is hardly a sensible central expectation. Messaging and policy response from the US Federal Reserve Bank should reflect the relatively high empirical risk that inflation may persist. 

Traditional capitalization-weighted indices generally add stocks with high valuation multiples after persistent outperformance and sell stocks at low valuation multiples after persistent underperformance. It is well known that the price impact of these changes can be large once a change is announced. The subsequent reversal is less well known. For example, in the year after a change in the S&P 500 Index, discretionary deletions beat additions by 22%, on average. Simple rules, such as trading ahead of index funds or delaying reconstitution trades by 3 to 12 months, can add up to 23 basis points a year. This benefit roughly doubles when we cap-weight a portfolio selected based on the fundamental size of a company’s business or on its multi-year average market-cap.

Implementation shortfall, whether from trading costs, discontinuous trading, or other frictions, erodes the performance of any investment strategy. These frictions, along with asset management fees, are the main sources of the sometimes-vast gap between live results and paper portfolio performance. Smart beta and factor strategies are not exceptions. In this paper, we investigate how smart rebalancing methods can capture most of the factor premia for a long-only paper portfolio, while cutting turnover and trading costs relative to a fully rebalanced portfolio. We demonstrate the efficacy of prioritizing trades to the stocks with the most attractive signals and of focusing portfolio turnover on the trades that offer the highest potential performance impact. 

Although hidden risks of factor investing can lead to investor disappointment, a variety of techniques can improve the risk-adjusted returns of individual factors and factor portfolios. Specifically, a new two-step volatility management approach, coupled with an optimization technique that captures volatility and correlation information, leads to improved risk-adjusted performance, lower volatility of volatility, and improved kurtosis and drawdown characteristics. 

Traditional cap-weighted indices generally add stocks with high valuation multiples and sell stocks at low valuation multiples. For the S&P 500 Index, in the year after a change in the index, additions lose relative to discretionary deletions by about 22%. Simple rules, such as trading ahead of index funds or delaying reconstitution trades by 3 to 12 months, can add up to 23 bps. This benefit doubles when a portfolio selected based on the fundamental size of a business or its multi-year average market cap is then cap-weighted.