Building on Finance Theory to Forge the Future of Investment Practice

by Bruce I. Jacobs and Kenneth N. Levy, Journal of Portfolio Management, Special 50th Anniversary Issue, November 2024: Neoclassical assumptions and a preference for parsimony have diminished the usefulness of academic pricing research when applied directly to complex, dynamic, and behavioral real-world markets... This article challenges those assumptions and presents examples of the authors’ research highlighting efforts to bridge the gap between theory and application. An active, dynamic, multifactor approach called smart alpha will help overcome the limitations of smart beta by accounting for a wider range of factors and changing market conditions. Mean-variance analysis will not yield optimal portfolios for leverage-averse investors, but mean-variance-leverage analysis will by accounting for investor aversion to leverage risk. Enhanced active equity long-short strategies provide improved efficient frontiers and portfolio efficiency by relaxing the long-only constraint while maintaining full benchmark index exposure. Asynchronous, discrete-time, dynamic simulations are more useful than continuous-time finance models for explaining the behavior of financial markets.

How Misunderstanding Factor Models Set Unreasonable Expectations for Smart Beta

by Bruce I. Jacobs, Kenneth N. Levy, and Sangwoo Lee, Journal of Portfolio Management, January 2025 (published online on November 1, 2024): The poor performance of some smart beta strategies in recent years is due to shortcomings of standard factor pricing models, from which the strategies draw their well-known factors... Inevitably, these factors include some that may fall out of favor, sometimes for extended periods, as market conditions change. Smart beta strategies also are limited by the standard factor models’ narrow focus on a handful of generic factors and a failure to take into account correlations between factors. Overcoming these limitations requires further steps toward a fully active, dynamic, multifactor approach, aka “smart alpha.”

Nobel Economics Prize Goes to 3 Professors for Research into Economic Consequences of Colonialism

by Rob Kozlowski, Pensions & Investments, October 14, 2024: Economists Daron Acemoglu, Simon Johnson, and James Robinson were awarded the Nobel Prize in Economics for research explaining how institutions created by European colonizers affected the long-term prosperity of their colonies. “When focused on the... extraction of resources, colonizers created inefficient economic and social institutions that persisted due to a ‘commitment problem’ — a belief that promises of political reform could not be trusted,” Bruce Jacobs said. “Whether a population was able to mobilize and become a threat determined whether it became trapped or was able to transition to more equitable institutions.” The laureates’ research “reinforces the conclusion that emphasizing democracy and inclusive institutions goes hand-in-hand with the goals of fighting poverty and promoting economic development,” Jacobs added.