'Lucking Up' - until beta fails

4 June 2020

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Throughout the last decade, barring the most recent COVID-19 sell off, holding equity beta exposure would have been a tremendous strategy. The US equity market delivered a Sharpe ratio of ~1, with most all other asset class benchmarks trailing. At the same time, uncorrelated liquid alternative strategies such as trend following (CTAs) delivered modest returns, overshadowed by the strong performance of equities (and bonds). In this note we illustrate to what extent the equity market rally from 2010 was a statistical fluctuation. We furthermore illustrate that the addition of an uncorrelated strategy with a Sharpe ratio of ~0.5 in any period outside of an ‘in-sample’ large positive fluctuation, such as was observed in 2010-2020, delivers overall better risk-adjusted portfolio performance. The natural conclusion to draw from the study is that, in the absence of being able to forecast such fluctuations, always allocating to uncorrelated, ‘alternative’ strategies delivers better forward looking outcomes.

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