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The LJE Asset Allocation, Long/Short and Hedging Strategies

July 26, 2020

The developments in Modern Portfolio Theory provide a framework for addressing the way risk can affect expected returns. We now have the Capital Asset Pricing Model (CAPM) which looks at the relationship between an investment’s risk and its expected market return. . The Sharpe-Lintner version of the CAPM yields a clear implication about portfolio strategies: All an investor can choose is the beta mix. But that is no reason to despair. The Smart Beta literature has an interesting insight. It argues that a cap-weighted equity index funds automatically increase their exposure to stocks whose prices appreciate and reduce their exposure to stocks whose prices fall. The proponents of the Smart Beta then argue that cap-weighting tends to overweight overvalued securities and underweight undervalued ones. Instead of accessing this market exposure via traditional cap-weighting, the Smart Beta advocates recommended the use of alternative-weighting schemes to increase the portfolio exposure to favored factors. It focuses directly on specific compensated factors such as size and location , i.e. domestic versus international , etc., According to street lore, at the height of his career, Wayne Gretzky was asked why he was such a great player when he was a slow skater. His answer was simple and straight forward. He said that instead of skating where the puck was , he skated to the where the puck was going to be . Investors have much to learn from Wayne Gretzky. We contend that investors may be able to determine what causes changes in these variables and thus anticipate and understand what drives these variables. Incorporating an economic viewpoint may enhance a beta strategy. This approach also suggests that explicit policy changes may alter the ability to respond to economic shocks, i.e. the reaction coefficient or industry beta. As a result, investors who pay attention to government regulations and technological innovations may be able to anticipate changes in industries and the economy responses to aggregate demand shocks. i.e. changes in beta and adjust its portfolio accordingly to deliver superior returns. This may allow investors to adjust their portfolios faster and ahead of the traditional estimates produced by the CAPM estimation techniques and thereby skate to where the puck is going to be.

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The ValueTiming™ strategy is based on the assumption that politicians and policymakers have particular views of the world, and that they will in general adopt policy measures that are consistent with these views.


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