Joachim Klement, CFA, demonstrates a method for beating average hedge fund returns — without the fees. It's the best dumb alpha can offer: a simple, low-cost investment strategy that outperforms more sophisticated and expensive alternatives.
Carry trades profit from investor herding just like momentum strategies. As more and more investors pour money into high-interest currencies and borrow on low-interest currencies, the demand for the former rises. This herding behavior can continue for quite some time, but it comes to a halt when investors are no longer willing to invest in high-interest currencies.
With short-term forecasts, random walks tend to outperform the accumulated wisdom of professional forecasters. That estimation uncertainty is not reduced for long-term forecasts either, because mean reversion cannot overcome the effects of compound interest. Luckily, there is a range of techniques, from simple to sophisticated, that can help long-term investors with this challenge.
Research confirms a “wisdom of the crowds” effect insofar as only a few analysts seem able to consistently outperform the consensus forecast compiled from many different analysts.
Passive investing is not actually passive. When looked at this way, it means there are important lessons for active investors. Examples include the hidden story behind market capitalization and the importance of low turnover. This also opens passive investing up to criticism regarding the free passes given to it in terms of risk, cost, and momentum.
Modern finance constantly busies itself with the development of new, more sophisticated ways to manage risk and generate returns. These efforts, however, generate their own risks. On the opposite end of the spectrum are simple ways to invest that have a proven track record of providing superior investment outcomes.
In part two of this discussion, Kevin Harney discusses the effects of the critical assumptions in finance and what can be done differently.
Finance rests upon several critical assumptions that have logical holes. Among the assumptions are: Brownian motion and normally distributed outcomes. Here is a discussion of some of the effects caused by these assumptions.
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