Dynamic Indexing and Allocation: Do they Dominate Simple Static Indexing?

23 Pages Posted: 22 Sep 2020

See all articles by Joseph E. McCarthy

Joseph E. McCarthy

Duke University

Edward Tower

Duke University - Department of Economics

Date Written: September 13, 2020


Andrew Lo in his book, Adaptive Markets, advocates an investment product that he names a “dynamic index.” He has facilitated the operation of a variant of this dynamic indexation, “dynamic allocation,” by founding a company, AlphaSimplex. Another dynamic investment is GMO’s Benchmark Free Allocation fund. We assess the role for dynamic investing with the AlphaSimplex funds and the GMO fund. The dynamic funds have higher expense ratios and turnover than static index funds do. Do the strategies of these funds add value, and if so is dynamic investing magical enough to overcome these hurdles? Do dynamic investments dominate a simple portfolio of static index funds with similar style rebalanced regularly whether risk adjusted or not and with or without differential expenses stripped away? We also clarify the interpretation of the Fama-French multi-factor models, generalize them, and discover the equivalence between the Fama-French and Sharpe (1992) approaches to mutual fund assessment. On average AphaSimplex funds underreturn portfolios of Vanguard index funds with the same style by 2.54 % age points per year. Some of that is because of expense ratios. Gross of expense ratios the average underreturn is 1.51 % age points/year.

Keywords: Mutual funds, index investing, dynamic indexing, alpha

JEL Classification: G1

Suggested Citation

McCarthy, Joseph E. and Tower, Edward, Dynamic Indexing and Allocation: Do they Dominate Simple Static Indexing? (September 13, 2020). Economic Research Initiatives at Duke (ERID) Working Paper No. 300, Available at SSRN: https://ssrn.com/abstract=3696507 or http://dx.doi.org/10.2139/ssrn.3696507

Joseph E. McCarthy (Contact Author)

Duke University ( email )

100 Fuqua Drive
Durham, NC 27708-0204
United States

Edward Tower

Duke University - Department of Economics ( email )

213 Social Sciences Building
Box 90097
Durham, NC 27708-0204
United States
919-660-1818 (Phone)
919-684-8974 (Fax)

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