Portfolio Structuring and the Value of Forecasting
40 Pages Posted: 31 May 2017
Date Written: August 2016
On 8 October 2015, CFA Montréal hosted its annual Asset Allocation Forum under the theme “Portfolio Structuring and the Value of Forecasting.” Two asset management approaches were compared:
• The factor investing approach, which relies on identifying common factors in security returns determining which factors represent compensated risks, and then extracting returns from a larger and more balanced set of compensated risks than traditional cap-weighted indices do
• The traditional approach, which relies on explicit forecasts of security - or industry-specific expected returns made by asset managers
Traditional asset management has sustained much criticism in recent years. Few active managers outperform their benchmark after fees over longer time horizons, such as 5 to 10 years. There has been much empirical evidence supporting the view that professional forecasters cannot predict or that their predictions explain only a very small part of the variability of asset returns. Hence, many investors are starting to embrace factor investing, which is becoming more commoditized and is often accessible at a lower cost.
However, even the factor investing approach relies on forecasts of expected returns, although the forecasts are implicit. Factor investors are not forecasting that the utility sector is likely to outperform the energy sector by X% over the next year (an explicit forecast), but they make the implicit forecast that, for example, value stocks are likely to outperform growth stocks in the long run. Hence, both approaches rely on some form of forecasting.
The objective of this forum was to shed some light on the factor investing approach, often called “smart beta,” while discussing recent developments in forecasting capabilities that may spur renewed interest in traditional asset management approaches.
The conference attracted five top speakers in their respective field. Two of these speakers discussed the factor approach - Andrew Ang of BlackRock and Mark Carhart, CFA, of Kepos Capital. The other three speakers discussed our ability to predict - Craig Bodenstab, CFA, of Orbis, David Rapach of Saint Louis University, and Philip E. Tetlock of the University of Pennsylvania. Each speaker wrote up the most important aspects of his speech, and the write-ups are included in this brief.
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