By |Published On: February 6th, 2018|Categories: Research Insights, Basilico and Johnsen, Academic Research Insight|

Hobbled by Benchmarks

  • Mike Aked, Rob Arnott, Omid Shakernia, Jonathan Treussard
  • Journal of Portfolio Management
  • A version of this paper can be found here
  • Want to read our summaries of academic finance papers? Check out our Academic Research Insight category.

What are the research questions?

Despite Peter Bernstein’s suggestion in 2003 that adherence to a fixed and undiversified policy portfolio is dangerous, benchmarks ( the most used of which is the 60/40) are as popular today as they were 15 years ago. The authors study the following research question:
  1. Is a broad investment opportunity set ( an un-levered and long-only version of a “value, momentum and carry” TAA system applied to a diverse universe of asset classes) a powerful source of incremental investment return?

What are the Academic Insights?

By studying three multi-asset class universes ( 2 assets US-based; 4 assets Globally-based; 15 assets Global diversified set) over the period from 1980 to 2016 and using simple model set-ups ( i.e. equal weighting of active TAA bets), the authors find the following:

  1. YES- An investor with a 2% peer-group active risk target could have added economically significant (annualized risk-adjusted alpha of 122 bps) returns in an un-levered and long only “diversified” portfolio by adding value, momentum and carry simple signals ( simplicity is used to avoid data mining). Additionally, the authors show that diversifying by strategy ( the combination of the different signals) or by the universe ( moving to the 15 asset class portfolio) coincides with a strong upward trend in alphas and t-stats.

Why does it matter?

While this study is simplistic, the authors hope to drive home the following message: “Please embrace diversification in your quest for long-term investment success.”

The Most Important Chart from the Paper:


In 2003, at the NMS Endowments and Foundations Conference, Peter Bernstein suggested that policy portfolios are overused, leading to excessive tracking-error constraints. In a 2004 article in this journal, Rob Arnott showed that the 20 largest U.S. corporate pension funds were willing to accept 12% annual volatility in total return, 15% volatility relative to liabilities, but only 2.5% tracking error relative to peers. Today, the use of policy portfolios is as dominant as it was 15 years ago; policy portfolios and their respective benchmarks continue to be a largely home-centric 60/40 allocation. In the view of the authors, there should be no debate on the benefits of broadly (i.e., globally) diversified policy portfolios. Broad diversification is a requirement for actively adding value over time. The authors believe that long-only investors can translate the lightly correlated sources of excess returns from the long–short space to their portfolios. They hope that investors will hear their plea: Please diversify your benchmarks.

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About the Author: Wesley Gray, PhD

Wesley Gray, PhD
After serving as a Captain in the United States Marine Corps, Dr. Gray earned an MBA and a PhD in finance from the University of Chicago where he studied under Nobel Prize Winner Eugene Fama. Next, Wes took an academic job in his wife’s hometown of Philadelphia and worked as a finance professor at Drexel University. Dr. Gray’s interest in bridging the research gap between academia and industry led him to found Alpha Architect, an asset management firm dedicated to an impact mission of empowering investors through education. He is a contributor to multiple industry publications and regularly speaks to professional investor groups across the country. Wes has published multiple academic papers and four books, including Embedded (Naval Institute Press, 2009), Quantitative Value (Wiley, 2012), DIY Financial Advisor (Wiley, 2015), and Quantitative Momentum (Wiley, 2016). Dr. Gray currently resides in Palmas Del Mar Puerto Rico with his wife and three children. He recently finished the Leadville 100 ultramarathon race and promises to make better life decisions in the future.

Important Disclosures

For informational and educational purposes only and should not be construed as specific investment, accounting, legal, or tax advice. Certain information is deemed to be reliable, but its accuracy and completeness cannot be guaranteed. Third party information may become outdated or otherwise superseded without notice.  Neither the Securities and Exchange Commission (SEC) nor any other federal or state agency has approved, determined the accuracy, or confirmed the adequacy of this article.

The views and opinions expressed herein are those of the author and do not necessarily reflect the views of Alpha Architect, its affiliates or its employees. Our full disclosures are available here. Definitions of common statistics used in our analysis are available here (towards the bottom).

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