Journal of Investment Strategies

Welcome to the third issue of the eighth volume of The Journal of Investment Strategies. In this issue, we have three papers offering different perspectives on investing.
The issue’s first paper, “Should we invest more in multinational companies when domestic markets decline?” by Martha O’Hagan-Luff, Jenny Berrill and Brian Lucey, uses a twenty-year data set of all publicly listed US firms from 1995 to 2014 to create a unique measure of both the extent and the scope of firm-level multinationality. Looking at the idea that investments in domestic multinational companies (MNCs) could provide an indirect route for investors to diversify internationally, the authors expect investors to increase their exposure to MNCs and decrease their exposure to domestic firms when the domestic market is declining. However, they discover that both retail and institutional investors favor domestic, rather than multi- national, companies in declining markets. Further, they find that domestic companies do outperform multinationals in declining markets.
The explanation given is that either the investors are irrational in their preference for domestic safety or they rationally believe that the theory of international diversification does not hold in bear markets. I believe the latter, because in the past twenty years, which is the scope of this paper, larger declines in US equity markets have been mostly in sync with global equity markets. As such, a rational investor might think that, in a coordinated downturn, US markets will provide greater safety than international markets. Only if the markets were less correlated would one prefer diversification.
“A consistent investment strategy” by Xianzhe Chen and Weidong Tian is our second paper. This contribution introduces a consistent performance strategy (CPS) that expands on the Merton intertemporal consumption framework to introduce stability criteria. Further, the paper presents relatively simple construction rules for optimal investment and consumption, which, if followed, lead to a wealth portfolio with consistently positive returns over time that exhibits a steady upward trend. The authors’ solution borrows insights from technical analysis and resembles constant proportional portfolio selection rules, well known from the prior literature. Both forward simulations and backtests confirm the results’ stability.
What I find curious about these results, however, is the propensity of consumption to drop even as wealth increases. It happens along with the growth of the safety cushion in the CPS portfolio. This is somewhat counterintuitive, as one would presumably prefer to spend more if one is more wealthy. If this reduction in consumption is indeed necessary for stability, we must decide whether the stability criterion should be adjusted to reflect end users’ actual desires for stable consumption as well as stable growth.
Finally, we have Andreas Thomann’s “Factor-based tactical bond allocation and interest rate risk management”. This paper offers two composite bond market factor investment strategies: one for the Swiss bond market and one for the global sovereign bond market. These composite factor strategies can be useful tools when making tactical asset allocation decisions between bonds and cash as well as between short- and long-duration bonds. The factors include both those intrinsic to the bond market, such as carry and curve steepness as well as bond market momentum, and those external to it, such as equity market momentum and business cycle. The authors demonstrate that the presented bond market factors can guide tactical interest rate views and aid in interest rate risk management, especially in a rising interest rate regime.
I find this paper very interesting, with many practical applications. The presented results seem sensible from a practitioner’s perspective. One important caveat, however, is that the premise of the study and the strategy is strongly dependent on the assumption that the bonds continue to be viewed as a defensive instrument in regimes of equity underperformance. While this has certainly been the case in recent decades, it is not a given that it will always be so. Further, with bond yields grinding lower and approaching zero in many developed countries, one wonders if the defensive capacity of the bond market is as strong as it once was. Still, the tactical strategy presented in this paper should perform better than a simple buy-and-hold, even in more nuanced circumstances.
I hope you enjoy reading these papers.
I would also like to take this opportunity to welcome Ali Hirsa, the new co-editor- in-chief of The Journal of Investment Strategies. Ali is a professor and co-director of financial engineering at Columbia University, where he leads one of the United States’s preeminent programs in quantitative finance. Under Ali’s guidance, many master’s students learn both traditional disciplines, such as portfolio theory, risk management and econometrics, and modern advanced topics, such as machine learning and computational methods in financial engineering. Ali is also a managing partner at Sauma Capital LLC, a New York hedge fund focused on systematic trading strategies. We look forward to his guidance and innovation as the journal enters this new year and decade.

Arthur M. Berd
Founder and CEO, General Quantitative LLC