Financial Anomalies in Asset Allocation: Risk Mitigation with Cross-Sectional Equity Strategies
The Journal of Portfolio Management, 49(1), 118-145, DOI: 10.3905/jpm.2022.1.422
Posted: 15 Apr 2022 Last revised: 19 May 2023
Date Written: March 11, 2022
Abstract
There is a myriad of financial anomalies in the cross-section of equity returns. They have been widely studied in the literature, which gives investors a large choice in terms of investment styles. In this paper, the authors show a perhaps unappreciated quality of financial anomalies: they exhibit a strong counter-cyclical behavior. Specifically, some anomalies (e.g., Profitability and Investment) perform particularly well when traditional portfolios (e.g., 60/40 or risk parity portfolios) exhibit prolonged periods of negative drawdowns and during NBER recessions. With the exception of momentum strategies, the authors do not find evidence that financial anomalies are inflation hedging. Last, the authors examine whether financial anomalies lead to better portfolio performance. The results show that combining anomalies based on their style and then adding them to a traditional portfolio leads to higher Sharpe ratios overall, while also limiting portfolio losses during recessions.
Keywords: Portfolio Allocation, financial anomalies, absolute return strategies, alpha strategies
JEL Classification: G10, G11, G12
Suggested Citation: Suggested Citation