Research Affiliates

Higher interest rates and inflation are likely to usher in a decade of policy restraint, limited liquidity and macro volatility, pressuring equities and motivating investors to reconsider tactical asset allocation and embrace real assets.

With artificial intelligence, systematic investing is entering a new era of disciplined decision-making. Yet, firms face many snags. Rigorous implementation requires collaboration among skillful investment, technology, and quantitative capabilities.

From 2007 to 2022, a hypothetical RAFI index, whose constituents are weighted based on their economic footprint, outperformed cap-weighted broad market and value indices not only in the US but also in Developed, Developed ex US, and Emerging Markets.

Nvidia is a key player in the AI revolution. Expectations, however, are truly astronomical and draw to mind past technology giants like Qualcomm and Cisco who grew into market leaders but offered disappointing returns to investors who bought at the peak.

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.

“Gold-standard” cap-weighted indices have a buy-high and sell-low dynamic that causes a structural long-term performance drag. Of course, relative to itself, no index can underperform, which is the reason it goes unnoticed. If we use a company’s fundamentals to choose stocks—and then cap-weights them – improves the risk-adjusted returns of gold-standard cap-weighted indices. This index, which we call Fundamental-selection Cap-weighted (FS-CW), has outperformed the most popular cap-weighted equity indices around the world over the last 30 years, while reducing risk, and with additional benefits of slightly lower turnover and transaction costs. Live results further support its merits. Building a better index fund that can earn a superior risk-adjusted return versus other cap-weighted indices is not only possible—it is a reality! 

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.