Strategic allocation to premiums in the equity market
Investors typically include equities in their asset allocation to earn the expected equity premium. But we argue that investors should explicitly consider all the premiums offered by the equity market, when making their strategic investment decisions.
Speed read
- Various premiums such as value or momentum can be captured
- Allocating to these premiums can have sizable benefits
- Premiums can be harvested both through passive and active vehicles
Investors tend to focus on harvesting the risk premiums offered by traditional asset classes when making their strategic investment decisions. Some recent papers, however, argue that investors should also consider various other premiums for possible inclusion in the strategic asset allocation. Examples of such premiums that have been documented for the equity market are the size, value, momentum and low volatility effects.
In this article1, the author demonstrates that the theoretically optimal strategic allocation to these premiums is sizable, even when using highly conservative assumptions regarding their future expected magnitudes. The pros and cons of two ways of obtaining the implied exposures in practice, specifically passively managed index funds versus actively managed quant funds, are also discussed.
1Blitz, D.C., 2012, ‘Strategic allocation to premiums in the equity market’, The Journal of Index Investing.
