Igor Yelnik

We introduce the notion of a patience premium, which is based on the concept of ambiguity aversion and is an ambiguity premium. We identify reasons for the existence of the patience premium.
The phenomenon of the patience premium helps explain why the performance of investment strategies may benefit from having longer holding periods.

The systematic style represents a combination of a systematic strategy (a.k.a. systematic model)’s decisions, and those of the portfolio manager. Whilst the model’s trades are implemented by changing positions in financial instruments, the systematic manager’s trades are changes made to the systematic strategy itself.
Statistical methods of evaluation of investment managers, be they discretionary or systematic, are only effective within certain limits.
Similarities between discretionary… Show more

The systematic style represents a combination of a systematic strategy (a.k.a. systematic model)’s decisions, and those of the portfolio manager. Whilst the model’s trades are implemented by changing positions in financial instruments, the systematic manager’s trades are changes made to the systematic strategy itself.
Statistical methods of evaluation of investment managers, be they discretionary or systematic, are only effective within certain limits.
Similarities between discretionary and systematic investment management firms, in terms of their exposure to the key person risk, are stronger than is commonly believed to be the case. Show less

We demonstrate that eigenvalues minimize information entropy of the main diagonal elements of a symmetric matrix over all possible orthogonal transforms. This legitimizes the use of the exponential entropy of standardized eigenvalues as a measure of effective covariance matrix dimensionality. In particular, this provides rigorous justification for the choice of the PCA basis in the construction of Effective Number of Trading Dimensions (ENTD).

How much risk does an investment portfolio turn over in a given period of time? In other words, how aggressively does it trade in terms of changing exposure to underlying risks? Rather surprisingly, the investment community still lacks a consistent definition that measures this important portfolio property. We argue that conventional Portfolio Turnover (PT), which quantifies trading intensity in nominal terms, does not serve this purpose well enough. We introduce an alternative measure that we… Show more

How much risk does an investment portfolio turn over in a given period of time? In other words, how aggressively does it trade in terms of changing exposure to underlying risks? Rather surprisingly, the investment community still lacks a consistent definition that measures this important portfolio property. We argue that conventional Portfolio Turnover (PT), which quantifies trading intensity in nominal terms, does not serve this purpose well enough. We introduce an alternative measure that we call Risk-based Portfolio Turnover, which, loosely speaking, represents the overall risk traded.

We also suggest a notion of Effective Number of Trades (ENT), which targets a related, but different question: how often does a portfolio make bets? Finally, we decompose trading activity by orthogonal axes and introduce the notion of Effective Number of Trading Dimensions (ENTD).

Both ENT and ENTD are invariant to linear transformations in a space of portfolio assets, which makes these two metrics important intrinsic portfolio characteristics. The paper is complemented with the R code for computing all the above measures. Show less

Active investment management is crucially dependent on skill, i.e. the ability to deliver consistent outperformance. All types of unique investment skill form a space. Understanding a basis of this space helps build portfolios of active strategies. We propose one such basis by representing an arbitrary investment process as an abstract information processing system. The obtained 5-dimensional skill-based classification is meant to complement existing classifications. Its purpose is to assist… Show more

Active investment management is crucially dependent on skill, i.e. the ability to deliver consistent outperformance. All types of unique investment skill form a space. Understanding a basis of this space helps build portfolios of active strategies. We propose one such basis by representing an arbitrary investment process as an abstract information processing system. The obtained 5-dimensional skill-based classification is meant to complement existing classifications. Its purpose is to assist investors in better understanding a menu of available investment strategies as well as to help asset managers to position themselves on that menu. We provide a detailed discussion of a risk premia related dimension of our proposed basis arguing that risk premia strategies require special skills. Show less

Allocation between factor portfolios can bring significant advantages over traditional portfolio optimization performed among individual assets or asset classes. One such advantage is a substantial dimension reduction when one’s attention turns from many assets to few factors. This, however, comes at the cost of decreased flexibility in satisfying portfolio constraints.

To address this problem, we suggest a natural approach inspired by a geometric interpretation of quadratic programming:… Show more

Allocation between factor portfolios can bring significant advantages over traditional portfolio optimization performed among individual assets or asset classes. One such advantage is a substantial dimension reduction when one’s attention turns from many assets to few factors. This, however, comes at the cost of decreased flexibility in satisfying portfolio constraints.

To address this problem, we suggest a natural approach inspired by a geometric interpretation of quadratic programming: among all feasible constrained portfolios, the optimal one minimizes tracking error with respect to the optimal unconstrained portfolio. Thus we obtain an optimal solution by "projecting" an optimal unconstrained factor portfolio onto a set of all feasible portfolios using tracking error as a distance measure. Doing so helps align alpha and risk factors in portfolio optimization. Show less

According to recent research, diversification across risk factors (or investment styles) proves to be more efficient than traditional asset class diversification. In this paper, we take the next step and show that it is economically worthwhile to combine risk factors in a dynamic manner, in a process that we call Dynamic Risk Allocation (DRA). Building a DRA portfolio by means of several unconventional heuristics adds robustness and intuition to the whole portfolio construction process. We… Show more

According to recent research, diversification across risk factors (or investment styles) proves to be more efficient than traditional asset class diversification. In this paper, we take the next step and show that it is economically worthwhile to combine risk factors in a dynamic manner, in a process that we call Dynamic Risk Allocation (DRA). Building a DRA portfolio by means of several unconventional heuristics adds robustness and intuition to the whole portfolio construction process. We provide strong empirical evidence that traditional global equity and bond premiums are absorbed by risk factor allocation (in expected utility maximization sense). Hence we question the economic validity of the alpha-beta separation paradigm that currently prevails in the industry. Adopting existing optimal rebalancing techniques, we show that our results are robust to transaction costs. In order to evince these statements, we analyze a global portfolio of 3 well-known risk factors: momentum, value and carry. To minimize data mining effects, each risk factor is broadly diversified across 4 global asset classes and taken both in cross-sectional and time series contexts. We test our approach using 38 years of daily historical prices in a broad set of futures contracts and major FX rates.
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This book chapter concentrates on similarities and distinctions between various global macro styles of investing, with a particular focus on an institutional investment approach typically referred to as ‘Global Tactical Asset Allocation’ or GTAA.