Larry Swedroe

Unlocking Cross-Asset Potential: A New Approach to Portfolio Construction

Christian Goulding and Campbell Harvey, authors of the study "Investment Base Pairs," proposed a groundbreaking framework for portfolio construction that challenges traditional approaches in modern finance. Their research focused on leveraging cross-asset information to optimize investment strategies and improve returns across diverse asset classes. Here's an overview of their investigation, key findings, and takeaways for investors and advisors.

Profitability Retrospective: Key Takeaways for Investors

Profitability subsumes all of the quality factor, explaining both the performance of the strategies the investment industry market and the factors that academics employ—none of the quality factors generated significant positive alpha relative to profitability, the other Fama and French factors, and momentum.

A New Approach to Regime Detection and Factor Timing

The financial research literature has found that the performance of assets (and factors)  can vary substantially across regimes - factor premiums can be regime dependent.  Unfortunately, the real-time identification of the current economic regime is one of the biggest challenges in finance.

Enhancing Industry Momentum Strategies: Finding Hidden Neighbors

The main benefit of constructing industry momentum portfolios based on standard ICS is that it is straightforward and reproducible. However, that benefit may come at the cost of accuracy and oversimplification of complex industry relationships between companies.

US Value Stocks Trading at Historically High Discounts

For equity investors there have been two major narratives over the last 17 calendar year period 2008-2024. The first is that US stocks have far outperformed international stocks. The other narrative has been the outperformance of growth stocks relative to value stocks.

Adverse Effects of Index Replication

The empirical research we have reviewed shows that the (hidden) costs of index construction and rebalancing policies to investors are about 10 times the expense ratios.

Valuations Reflect U.S. Exceptionalism

US exceptionalism provided the same explanation for the outperformance of US stocks in the 1990s. However, that regime changed. From 2000-2007, while the S&P 500 Index returned just 1.9% per annum (underperforming riskless one-month Treasury bills by 1.3% per annum), the MSCI EAFE Index returned 5.6% per annum, and the MSCI Emerging Markets Index returned 15.3% per annum.

Listing Domicile Driving Valuations

The listing domicile explained about 50% of the valuation gap. In other words, US-listed stocks are substantially more expensive than internationally listed stocks for no reason other than the place of listing.

The Ability to NAV Time Interval Funds

NAV timing investors could potentially create trading strategies which would systematically transfer wealth from buy-and-hold investors to themselves.

Is There A Bubble In Private Credit?

While the media headlines are preaching doom, the fundamentals are telling a very different story—credit spreads have widened, and EBITDA multiples are the lowest they have been in a decade. The bottom line is that for investors able to accept its limited liquidity, private, senior, secured and sponsored by private equity direct lending continues to be a compelling component of a diversified portfolio deliver what has always attracted investors: high current income, resilience through market cycles, and a disciplined approach to risk management. We are far from a bubble.  

Nine Lessons the Market Taught in 2024

In 2024 investors were provided with nine lessons. Many of them are repeats from prior years. Unfortunately, too many investors fail to learn them—they keep making the same errors.

Private Credit: Upper Versus Lower Middle Market Lending

Given the similar net returns that UMM and LMM loans have delivered, allocators should consider diversifying across borrower size cohorts. Since LLM loans are somewhat riskier, careful due diligence should be performed in terms of a lender’s credit loss history, fees/expenses, and use of leverage.

Investigating Simple Formulaic Investing

Simple, easy-to-implement, systematic formula-based investing can still generate market outperformance, providing investors with efficient exposure to well-documented factor premiums.

Private Equity Versus Public Equity Returns

Cliffwater found that private equity allocations by state pensions produced a 11.0% net-of-fee annualized return over the 23-year period ending June 30, 2023. Over the same period the CRSP 1-10 Index (U.S. total market) returned 7.2% and the MSCI All Country World ex USA Index returned 4.4%.

Improving Low Volatility Strategies

The bottom line is that returns to the low volatility anomaly have only justified investing when low-volatility stocks were in the value regime, after periods of strong market performance, and when they excluded high-volatility stocks that have low short interest (providing clues as to how to improve its performance). This may be why live funds have been generating large negative alphas once we account for common factor exposures.

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Important Disclosures

Performance figures contained herein are hypothetical, unaudited and prepared by Alpha Architect, LLC; hypothetical results are intended for illustrative purposes only. Past performance is not indicative of future results, which may vary. There is a risk of substantial loss associated with trading stocks, commodities, futures, options and other financial instruments. Full disclosures here.

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