Table of Contents

Acknowledgments ix

Preface xi

Introduction 1

PART I: THE ACTIVE MANAGEMENT BUSINESS 5

CHAPTER 1: The Economics of Active Management 7

Understanding Active Management 8

Evidence on the Relative Performance of Active Managers 12

Relevance of Funds’ Performance Measures 15

Closing Remarks 17

CHAPTER 2: What Factors Drive Performance? 21

Implications of Long Performance Cycles and Management Styles 22

Ability to Identify Performing Managers 28

Replicating the Performance of Mutual Fund Managers 32

Closing Remarks 35

CHAPTER 3: Outperforming Which Index? 39

Purpose and Diversity of Financial Indices 40

Building an Index 41

Are Cap-Weight Indices Desirable? 43

Alternatives to Cap-Weight Indices and Implications 44

Closing Remarks 48

PART II: UNDERSTANDING THE DYNAMICS OF PORTFOLIO ALLOCATION AND ASSET PRICING 51

CHAPTER 4: The Four Basic Dimensions of An Efficient Allocation Process 53

First Dimension: Understanding Volatility 54

Second Dimension: Increasing the ARI Mean 68

Third Dimension: Efficiently Maximizing GEO Mean Tax 69

Fourth Dimension: Accounting for Objectives and Constraints 70

Closing Remarks 71

CHAPTER 5: A Basic Understanding of Asset Valuation and Pricing Dynamics 75

Determinants of Interest Rates 76

Determinants of Equity Prices 80

Historical Returns as a Predictor 86

Other Predictors 91

Review of Predictors 107

Closing Remarks 108

PART III: THE COMPONENTS OF AN EFFICIENT PORTFOLIO-ASSEMBLY PROCESS 113

CHAPTER 6: Understanding Nonmarket-Cap Investment Protocols 115

Risk-Based Protocols 115

Fundamental Protocols 128

(Risk) Factor Protocols 135

Comparing and Analyzing Protocols 142

Bridging the Gaps and Improving on the Existing Literature 144

A Test of Several Investment Protocols 148

Closing Remarks 157

CHAPTER 7: Portfolio Rebalancing and Asset Allocation 161

Introduction to Portfolio Rebalancing 161

The Empirical Literature on Rebalancing 170

A Comprehensive Survey of Standard Rebalancing Methodologies 175

Asset Allocation and Risk Premium Diversification 179

Volatility and Tail Risk Management 190

Volatility Management versus Portfolio Insurance 197

Closing Remarks 199

CHAPTER 8: Incorporating Diversifiers 203

Fair Fees 204

Risk Premium and Diversification 205

Commodities as a Diversifier 208

Curencies as a Diversifier 228

Private Market Assets as a Diversifier 244

Closing Remarks 250

CHAPTER 9: Allocation Process and Efficient Tax Management 255

Taxation Issues for Individual Investors 256

Components of Investment Returns, Asset Location, Death and Taxes 257

Tax-Exempt, Tax-Deferred, Taxable Accounts and Asset Allocation 260

Capital Gains Management and Tax-Loss Harvesting 276

Is It Optimal to Postpone Net Capital Gains? 280

Case Study 1: The Impact of Tax-Efficient Investment Planning 289

Case Study 2: Efficient Investment Protocols and Tax Efficiency 291

Closing Remarks 293

PART IV: CREATING AN INTEGRATED PORTFOLIO MANAGEMENT PROCESS 295

CHAPTER 10: Understanding Liability-Driven Investing 297

Understanding Duration Risk 298

Equity Duration 303

Hedging Inflation 307

Building a Liability-Driven Portfolio Management Process 310

Why Does Tracking Error Increase in Stressed Markets? 312

Impact of Managing Volatility in Different Economic Regimes 314

Incorporating More Efficient Asset Components 320

Incorporating Illiquid Components 322

Role of Investment-Grade Fixed-Income Assets 323

Incorporating Liabilities 324

Incorporating an Objective Function 325

Case Study 326

Allocating in the Context of Liabilities 331

Closing Remarks 335

CHAPTER 11: Conclusion and Case Studies 337

Case Studies: Portfolio Components, Methodology and Performance 340

Conclusion 349

Bibliography 351

Index 361

About the Author

JACQUES LUSSIER, PhD, CFA, is the Chief Investment Strategist at Desjardins Asset Management, and has been with the company since 1995. He is the current VP of the Montreal chapter of the CFA (Chartered Financial Analyst) Society. He is a regular speaker at conferences, seminars, and webinars. Previously, Mr. Lussier taught finance at HEC Montréal. He holds a PhD in International Business with a minor in Bank Studies from the University of South Carolina, a master’s degree in Finance and a bachelor’s degree in Economics from HEC Montréal.