Smart beta strategies promise to deliver market-beating returns with simplicity and low cost, but the reality is more complicated. Contrary to popular perception, smart beta strategies are neither passive nor well diversified. Nor can they be expected to perform consistently in all market...

Leverage entails a unique set of risks, such as margin calls, which can force investors to liquidate securities at adverse prices. Modern Portfolio Theory (MPT) fails to account for these unique risks. Investors often use portfolio optimization with a leverage constraint to mitigate the risks of...

This editorial, which mirrors Bruce Jacobs's book Too Smart for Our Own Good: Ingenious Investment Strategies, Illusions of Safety, and Market Crashes, finds that “free-lunch” strategies and products that promise to increase returns while reducing risk can attract substantial investments and...

The mean-variance-leverage (MVL) optimization model (Jacobs and Levy 2012, 2013a) tackles an issue not dealt with by the mean-variance optimization inherent in the general mean-variance portfolio selection model (GPSM) — that is, the impact on investor utility of the risks that are unique to...

Stephen A. Ross had an uncanny talent for translating economic theory into intuitive and rigorous concepts that were useful to researchers and practitioners alike. His most famous accomplishment, the arbitrage pricing theory, has inspired the ongoing search for factors that explain security...

The credit crisis reflects the collapse of a tower of structured finance products based on subprime mortgage loans. These instruments-RMBSs, CDOs, SIVs, and CDSs-shifted the risk of mortgage lending, especially the default risk, from one party to another, until many lost sight of the real risks...

Enhanced active equity strategies, including 120-20 and 130-30 long-short portfolios, have become increasingly popular as managers and investors search for new ways to expand the alpha opportunities available from active management. But these strategies are not always well understood by the...

Investors who buy ldquo;insurancerdquo; against a decline in stocks, bonds, or other financial markets are shifting that risk onto the financial institutions providing such ldquo;insurance.rdquo; These insurance providers frequently control their exposure to this risk by purchasing options or by...

More than three decades ago, Jacobs and Levy introduced in the Financial Analysts Journal the idea of disentangling returns across numerous factors via cross-sectional analysis, and examined the benefits of using the time-series of returns to disentangled factors for return forecasting. The...

We consider the optimality of portfolios not subject to short-selling constraints and derive conditions that a universe of securities must satisfy for an optimal active portfolio to be dollar neutral or beta neutral. We find that following the common practice of constraining long–short...