AgPa #70: Equal vs. Market Cap Weights

Why Do Equally Weighted Portfolios Beat Value-Weighted Ones? (2022)
Alexander Swade, Sandra Nolte, Mark Shackleton, Harald Lohre
The Journal of Portfolio Management 49 (5), URL/SSRN

This week’s AGNOSTIC Paper examines one of the most common ideas of portfolio construction. Equal weighting. At least on paper, equal weighted strategies often outperform market cap weights and sometimes even more sophisticated optimizations. In a very simple, yet somehow brilliant analysis, this week’s authors examine where this historical outperformance comes from…

  • EW portfolios outperformed VW ones in the US market
  • EW bets on Size, Value, and against Momentum, Quality, and Low-Risk
  • The EW-VW spread is an imperfect, but cheap and simple proxy for the size effect

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AgPa #69: Rebalancing Luck

Fundamental Indexation: Rebalancing Assumptions and Performance (2010)
David Blitz, Bart van der Grient, Pim van Vliet
The Journal of Index Investing Fall 2010, 1(2), URL/SSRN

This week’s AGNOSTIC Paper is already more than 10 years old, but still carries a very important message. The core idea is very simple. If you design an investment strategy, you must make decisions about rebalancing. There are two aspects to consider. How much and when. This week’s authors examine the when at the example of fundamental indices. They show that choosing arbitrary rebalancing date(s) introduces substantial luck or bad luck to a strategy. Even more important, this luck or bad luck doesn’t seem to cancel out over time and thus permanently affects real-world returns. Fortunately, however, there are ways to make yourself less dependent from rebalancing luck…

  • Different rebalancing dates lead to different outcomes
  • Rebalancing luck (or bad luck) is relevant and persistent
  • There is a solution: stretch rebalancing over the year

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AgPa #58: International Diversification – Doing the Right Thing is Hard Sometimes

International Diversification—Still Not Crazy after All These Years (2023)
Cliff Asness, Antti Ilmanen, Dan Villalon
The Journal of Portfolio Management 49(6), 9-18, URL/AQR

In the last post (AgPa #57), we have already seen that international diversification is a powerful protection against the higher-than-expected risk of losing real wealth with stocks over the long term. By coincide, three of the OGs from AQR Capital Management also just released an article about the Fors and Againsts of international diversification. Unsurprisingly, I picked that one for this week’s AGNOSTIC Paper…

  • For: Not everyone can invest in the best-performing market
  • Against: Everything crashes together
  • For: Historic returns don’t show changes in valuation
  • For: Valuation levels should eventually matter
  • For: International diversification provides opportunities for active investors

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AgPa #53: Investing in Interesting Times

Investing in Interesting Times (2023)
Annti Ilmanen
The Journal of Portfolio Management Multi-Asset Special Issue 2023, URL/AQR

Almost exactly one year ago, Antti Ilmanen (Partner at AQR Capital Management) released his outstanding book Investing Amid Low Expected Returns: Making the Most When Markets Offer the Least. The book is (in my opinion) a must-read and the timing couldn’t have been better. Many of the key themes began to materialize in 2022. Given how much markets have changed since then, Antti released a few updates for six of his major ideas in this week’s AGNOSTIC Paper.

  • The low expected return challenge
  • Investors’ response to low expected returns – private markets
  • What happened in 2022 and where we stand now
  • Long-only versus long-short strategies
  • Downside protection via trend-following

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AgPa #47: Equity Factors without Shorting

When Equity Factors Drop Their Shorts (2020)
David Blitz, Guido Baltussen, Pim van Vliet
Financial Analysts Journal, 76(4), URL

This week’s AGNOSTIC Paper examines the important issue of performance contributions from the long and short legs of the major factor premiums. In English: can we profitably invest in factors without shorting a large number of stocks?

  • The long-legs of factors are more important than the short-legs
  • The same pattern holds in international markets

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AgPa #46: Transaction Costs and Capacities of Factor Strategies

Transaction Costs of Factor-Investing Strategies (2019)
Feifei Li, Tzee-Man Chow, Alex Pickard, Yadwinder Garg
Financial Analysts Journal 75(2), 47-61, URL

In this week’s AGNOSTIC paper, the authors develop a transaction cost model and use it to estimate the capacity of the major factors. There are many ways to define capacity in more detail, but the general idea is quite simple. It is the amount of money you can invest in a profitable strategy before you move prices too much and lose your advantage. Unfortunately, what theoretically sounds simple and intuitive is actually quite difficult to estimate in practice…

  • Implementation costs depend on tilt, turnover, and execution speed
  • Capacities of factors for a maximum cost of 0.5% per year
  • There is not yet a consensus on factor capacities

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AgPa #29: Cost-Mitigation Techniques

Comparing Cost-Mitigation Techniques (2019)
Robert Novy-Marx, Mihail Velikov
Financial Analysts Journal 75(1), 85-102, URL/SSRN

This week’s AGNOSTIC Paper examines three techniques to mitigate trading costs of systematic equity strategies and compares them by after-cost performance. The empirical evidence clearly speaks for the application of more sophisticated trading rules (Technique #3)…

  • Trading costs decreased but are still important
  • Technique #1: focus on “cheap-to-trade” securities
  • Technique #2: rebalance less frequently
  • Technique #3: create better trading rules
  • Value- versus equal-weighted portfolios

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