“Nothing in excess.” – Inscription from the temple of Apollo at Delphi  (Wikipedia)

The financial crisis and ensuring bear market threw the traditional idea of asset allocation out the window.  In the past few years record levels of correlation amongst asset classes and within asset classes has diminished the volatility reducing effects of diversification.  For some this has meant throwing out the idea of diversification and simply retreating to cash.

There is another approach to portfolio construction that leaves aside traditional asset classes and focuses on various risk strategies instead.  The vast majority of investors, including nearly all institutional investors, need to stay invested in some form or fashion.  Therefore a focus on these risk strategies like size, value, momentum and low volatility may make more sense.

Tobias Moskowitz in Bloomberg looks at the utility of focusing on momentum and value strategies in a combined fashion within and across asset classes He notes that the two strategies work at different frequencies:

Hence, the two strategies are related. Typically, when one works, the other doesn’t. The technology boom of the mid-to-late 1990s provides an example. Value investing produced very poor returns during this period as hot tech stocks that seemed expensive became more expensive. A momentum strategy produced big returns during this time.

A perfect example of this is the recent performance of momentum strategies.  After having been on an “epic winnings streak” momentum strategies in US equities have given back much of their gains.  Hence the need for a more diversified approach.  Moskowitz goes on to note how working in tandem the two strategies can help generate more attractive portfolio-level returns.

Taken together, value and momentum provide long-term positive returns and offset much investment risk, even more so when applied across markets and asset classes simultaneously…While the performance of any approach in any given year is never certain, the long-term performance of a combination of these two known investment styles has been consistent.

David Blitz in a recent research paper goes on to show how one might try to combine various strategies into a portfolio.  He finds that portfolios with significant allocations to value, momentum and low volatility strategies demonstrate higher Sharpe ratios than the market portfolio.

The investment world is filled with investors who self-identify as either value or momentum investors.  The degree to which both strategies work is because they impose significant psychological costs on their followers.  This includes the desire to abandon the strategy during the inevitable periods of underperformance.  Therefore combining the two strategies, in addition to others, can help smooth out the returns along the way.  In addition there are a slew of new ETFs that focus on these various strategies that can be used to implement this kind of approach.

Another phrase of Greek origin seem to fit this approach to asset management: “Moderation is best.” A reliance on any single investment strategy is for most investors going to be a tough psychological challenge. An approach to that diversifies, albeit in an unconventional fashion, is more likely to make for more consistent results over time.

Items mentioned above:

A blended investment strategy for all markets.  (Bloomberg earlier SSRN)

Momentum finished?  (Turnkey Analyst)

Strategic allocations to premiums in the equity market.  (SSRN)

New factor-based ETFs.  (IndexUniverse)

[earlier] Behavior gap illustrated.  (Abnormal Returns)

[earlier] Correlation questions.  (Abnormal Returns)

List of Greek phrases.  (Wikipedia)

This content, which contains security-related opinions and/or information, is provided for informational purposes only and should not be relied upon in any manner as professional advice, or an endorsement of any practices, products or services. There can be no guarantees or assurances that the views expressed here will be applicable for any particular facts or circumstances, and should not be relied upon in any manner. You should consult your own advisers as to legal, business, tax, and other related matters concerning any investment.

The commentary in this “post” (including any related blog, podcasts, videos, and social media) reflects the personal opinions, viewpoints, and analyses of the Ritholtz Wealth Management employees providing such comments, and should not be regarded the views of Ritholtz Wealth Management LLC. or its respective affiliates or as a description of advisory services provided by Ritholtz Wealth Management or performance returns of any Ritholtz Wealth Management Investments client.

References to any securities or digital assets, or performance data, are for illustrative purposes only and do not constitute an investment recommendation or offer to provide investment advisory services. Charts and graphs provided within are for informational purposes solely and should not be relied upon when making any investment decision. Past performance is not indicative of future results. The content speaks only as of the date indicated. Any projections, estimates, forecasts, targets, prospects, and/or opinions expressed in these materials are subject to change without notice and may differ or be contrary to opinions expressed by others.

Please see disclosures here.

Please see the Terms & Conditions page for a full disclaimer.