Pushing The Diversification Frontier With True Factor Investing


Key takeaways:

Alternative sources of diversity come from sources of edge that exploit behavior and structural phenomenon in markets
  • Factors: long/short portfolios sorted on things like value, momentum, quality
  • Carry: divs, futures roll down
These sources also exist cross-asset
A lot of people talk about these factor premia or alternative style premia purely in the domain of security selection, but it's not isolated to that. The exact same effect plays out in the multi-asset space as well. So buying asset classes with strong momentum or strong carry, has the same, or in many cases an even more powerful effect over the long term than we see in the security space. And we're talking about the factors that are most pervasive. We see them everywhere in every geography and across different security types, and asset classes. They're persistent.
Example portfolio
  • 40% global diversified risk parity portfolio of traditional asset classes
  • 40% diversified style premium (ie value, defensive carry, and momentum)
These 2 prior buckets are pro-cyclical or “concave”. In times of stress, they will struggle at the same time. So add another bucket that has tended to work counter-cyclically:
  • 20% trend-following
This sample portfolio has a high diversification ratio so it would make sense to lever it.
Worth noting that the 2010s has been a challenging decade for diversification but not out of the range of expectations.