Portfolio Construction

New Rules of Diversification

During the first half of 2022, equity markets tumbled around 20% from their peak, with losses on typical stock/ bond portfolios almost as large. More worryingly, this type of downturn may be unfamiliar to many younger investors: with inflation still high, there is little prospect of central banks riding to the market’s rescue. We assess the prospects for stock and bond markets after the H1 selloff, consider the impact of macroeconomic risks on a range of investments, and explore the use of diversifying investments to fortify portfolios.

Subscribe for more insights

Alternative Investing

A Better Alternative: Diversify Your Diversifiers

After the strong performance of stocks and bonds over the last decade may come a long hangover, as investors today face anemic 5-10 year returns in traditional asset classes. Some liquid alternatives represent an attractive option but come with their own challenges. Our solution is to focus on truly diversifying alternatives and diversify across them – resulting in returns that may be less volatile, and a portfolio that may be easier to stick with.

Machine Learning

Machine Learning and the Implementable Efficient Frontier

We propose that investment strategies should be evaluated based on their net-of-trading-cost return for each level of risk, which we term the "implementable efficient frontier." While numerous studies use machine learning return forecasts to generate portfolios, their agnosticism toward trading costs leads to excessive reliance on fleeting small-scale characteristics, resulting in poor net returns. We develop a framework that produces a superior frontier by integrating trading-cost-aware portfolio optimization with machine learning

Portfolio Construction

New Rules of Diversification

During the first half of 2022, equity markets tumbled around 20% from their peak, with losses on typical stock/ bond portfolios almost as large. More worryingly, this type of downturn may be unfamiliar to many younger investors: with inflation still high, there is little prospect of central banks riding to the market’s rescue. We assess the prospects for stock and bond markets after the H1 selloff, consider the impact of macroeconomic risks on a range of investments, and explore the use of diversifying investments to fortify portfolios.

ESG Investing

ESG Ratings: A Compass without Direction

We examine the recent concerns about the reliability of the assessments of ESG ratings providers. We review the demand for ESG information, the stated objectives of ESG ratings providers, how ratings are determined, the evidence of what they achieve, and structural aspects of the industry that potentially influence ratings. We find that while ESG ratings providers may convey important insights into the nonfinancial impact of companies, significant shortcomings exist in their objectives, methodologies, and incentives which detract from the informativeness of their assessments.

Tax Aware

Now You Don’t Have to Choose Between Diversification and Tax Efficiency

The additional requirement for individuals and families is for their diversifying strategies to be attractive not just pre-tax, but also net of taxes.

Tax Aware

Regardless of How You Deal with Low-Basis Stock, Long-Short Strategies Can Help

Most investors recognize that concentrated stock holdings are risky, but the outright sale of a low-basis stock incurs a punitive tax burden. In this post, we highlight several tax-efficient alternatives to an outright sale and explore how long/short strategies can help enhance this tax efficiency.

ESG Investing

A Fireside Chat with Cliff Asness and Institutional Investor on ESG Investing

AQR Managing and Founding Principal Cliff Asness sat down with Institutional Investor Editor-in-Chief Michael Corcoran to answer some of the key questions on ESG investing. The conversation covered how a quantitative manager can effectively engage with companies, how investors can use their portfolios to help address climate change, why shorting is an effective ESG tool, and more.

Portfolio Construction

The Stock/Bond Correlation

For the past two decades, the stock/bond correlation – a fundamental detriment of risk in traditional portfolios – has been consistently negative. However, this hasn’t always been the case, and a positive stock/bond correlation could reappear due to macroeconomic changes. In this article, we assess the broad implications this would have for investors and set out practical steps to prepare for such an outcome.

Tax Aware

When Fortune Doesn’t Favor the Bold: Perils of Volatility for Wealth Growth and Preservation

Entrepreneurs and executives holding much of their wealth in a highly appreciated single stock face either the high risk of idiosyncratic volatility and potentially catastrophic losses, or selling stock and facing an immediate, punitive tax burden. This paper evaluates this choice and explains how it relates to classic betting strategies and economic theory, finding tax-efficient techniques might strike the balance between the urgency to diversify concentrated risk and aversion to taxes.

ESG Investing

Supply Chain Climate Exposure

To manage climate risks, investors need reliable climate exposure metrics, but such risks may be difficult to measure, particularly along the supply chain. Using broadly accessible data, we propose an intuitive metric that quantifies the exposure a company has to customers and suppliers. Our metric is related to scope 3 emissions and captures the strength of economic linkages as well as the overall climate exposure of a firm’s customers and suppliers.