Previous research has shown that equally weighted portfolios outperform optimized portfolios, which suggests optimization adds no value in the absence of informed inputs. This article argues opposite. With naive inputs, usually portfolios. The ostensible superiority 1/N approach arises not from limitations but, rather, reliance on rolling short-term samples for estimating expected returns. often yields implausible expectations. By relying longer-term returns or even naively contrived yet...

Regime shifts present significant challenges for investors because they cause performance to depart significantly from the ranges implied by long-term averages of means and covariances. But regime also opportunities gain. The authors show how apply Markov-switching models forecast regimes in market turbulence, inflation, economic growth. They found that a dynamic process outperformed static asset allocation backtests, especially who seek avoid large losses.

In the face of accelerating climate change, investors are making capital allocations seeking to decarbonize portfolios by reducing carbon intensity their holdings. To understand performance portfolio decarbonization strategies and investor behavior toward decarbonization, authors construct factors that go long low-carbon-intensity short high-carbon-intensity sectors, industries, or companies. They consider several formation find lowered emissions more aggressively performed better....

We analyze how the use of different climate risk measures leads to portfolio carbon outcomes and risk-adjusted returns. Our findings are synthesized in a rules-based investment framework, which selects type metric across industries weighs based on variability among firms within each industry. conclude that analyzing merits applicability various data can help investors manage while increasing

The authors propose a simple analytical construct for incorporating liquidity into portfolio choice. In cases where investors deploy to raise portfolio's expected utility beyond its original utility, the attach shadow asset tradable assets. prevent from falling, liability assets that are not tradable. This lets determine optimal allocation illiquid Alternatively, can use this estimate premium an requires, or degree which they must benefit in order justify forgoing investment approach...

In the face of accelerating climate change, investors are making capital allocations seeking to decarbonize portfolios by reducing carbon emissions their holdings. To understand performance portfolio decarbonization strategies and investor behavior towards we construct factors that go long low intensity sectors, industries, or firms short high intensity. We consider several formation find lowered more aggressively performed better. Decarbonization factor returns associated with...

Kinlaw, Kritzman, and Turkington introduce a methodology for measuring systemic importance. Investors care about importance because this knowledge may enable them to assess their portfolio’s vulnerability particular events and, if warranted, pursue defensive strategies. Policymakers also need information ensure that policies regulations target the appropriate entities more effectively engage in preventive or corrective measures when circumstances warrant intervention. The absorption ratio,...

It is reasonable to expect that changes in private equity valuations should bear some correspondence public performance because assets and both respond common influences such as discount rates. But it also recognize depart extent from owing differences risk, liquidity, cash flow expectations. These affect the degree of correspondence. In this article, authors explore an additional influence on affects not correspondence, but rather symmetry The argue managers are less constrained than market...

The complexity of machine learning models presents a substantial barrier to their adoption for many investors. algorithms that generate predictions are sometimes regarded as black box and demand interpretation. In this article, the authors present framework demystifying behavior models. They decompose model into linear, nonlinear, interaction components study model’s predictive efficacy using same components. Together, forms fingerprint summarize key characteristics, similarities,...

Soon after Harry Markowitz published his landmark 1952 article on portfolio selection, the correlation coefficient assumed vital significance as a measure of diversification and an input to construction. However, investors typically overlook potential for patterns help predict subsequent return risk. Kritzman Li (2010) introduced what is perhaps first capture degree multivariate asset price 'unusualness' through time. Their financial turbulence score spikes when prices 'behave in...

Financial analysts typically estimate volatilities and correlations from monthly or higher-frequency returns when determining the optimal composition of a portfolio. Although it is widely acknowledged that these measures are not necessarily stationary across samples, most assume implicitly that, within sample, scale with square root time estimated high-frequency similar to low-frequency returns. Evidence does support this view. Instead, evidence shows relative asset values often evolve...

Crowded trades are often associated with bubbles. If investors can locate a bubble sufficiently early, they profit from the run-up in prices. But to bubble, must exit before sell-off erodes all of profits. The authors propose two measures for managing exposure One measure, called <i>asset centrality</i>, locates crowded trading, which show is formation other measure relative value, helps separate crowding that occurs during bubble's sell-off. Neither by itself sufficient identifying full...

Financial analysts assume that the reliability of predictions derived from regression analysis improves with sample size. This is thought to be true because larger samples tend produce less noisy results than smaller samples. But this not always case. Some observations are more relevant others, and often one can obtain reliable by censoring sufficiently relevant. The authors introduce a methodology for identifying recasting prediction equation as weighted average historical values dependent...

The Sharpe ratio is the most widely used metric for comparing performance across investment managers and strategies, information as commonly to evaluate relative a benchmark. Although it recognized that non-linearities arising from inclusion of options or deployment dynamic trading rules may distort these metrics, analysts are unaware another, perhaps more serious source distortion. Most analysts, either consciously unthinkingly, assume standard deviations scale with square root time...

That investors should diversify their portfolios is a core principle of modern finance. Yet there are some periods in which diversification undesirable. When the portfolio's main growth engine performs well, prefer opposite diversification. An ideal complement to would provide when it poorly and unification well. Numerous studies have presented evidence asymmetric correlations between assets. Unfortunately, this asymmetry often undesirable variety: It characterized by downside upside In...

The authors evaluate the merits of factor stratification as an alternative to asset stratification. Their analysis reveals that it is more challenging use factors than assets building blocks for forming portfolios because covariances are less stable covariances. Nonetheless, may be advantageous a variety other reasons. It certain offer risk premiums; or could by decomposing portfolio into set exposures, investors will discover unintended risks. And awareness portfolio’s exposures help...

Investors rely on the stock-bond correlation for a variety of tasks, such as forming optimal portfolios, designing hedging strategies, and assessing risk. Most investors estimate stock–bond simply by extrapolating historical monthly returns; they assume that this best characterizes future annual or multiyear returns, but approach is decidedly unreliable. The authors introduce four innovations generating reliable prediction correlation. First, show how to represent single-period cumulative...

We show that the differential in trailing equity market performance across countries strongly predicts cross-section of currency returns. Specifically, exchange rates tend to appreciate for with strongest returns preceding year. Portfolios formed on this factor have outperformed those traditional carry, trend, and valuation factors currencies since 1990. The cannot be explained by these produces a statistically significant alpha excess them. Its is remarkably consistent robust different...

Investors have long relied on scenario analysis as an alternative to mean–variance help them construct portfolios. Even though accounts for all potential scenarios, many investors find it difficult implement because requires specify statistical features of asset classes that are often unintuitive and estimate. Scenario analysis, by contrast, only a small set outcomes projections economic variables assign probabilities their occurrence. It is, therefore, more intuitive than but is highly...

The authors introduce a new index of the business cycle that uses Mahalanobis distance to measure statistical similarity current economic conditions past episodes recession and robust growth. Their has several important features distinguish it from Conference Board’s leading, coincident, lagging indicators. It is efficient because as single conveys reliable information about path cycle. gives an independent assessment state economy constructed variables are different than those used by...

The conventional approach for addressing estimation error in portfolio construction is to devise techniques reducing the errors, such as compressing all estimates toward a cross-sectional average or some other prior belief. In this article, authors propose an alternative dealing with error, arguing that may be more less stable than others. rather attempting mitigate by making similar each other, managers should measure their relative stability and form portfolios explicitly account feature,...