The Long Revolution

Asset classes typically have multiple factors driving their returns, some of which are common to many asset classes. Depending on which return drivers are dominant at any time, an asset class has volatility that varies over time, and different asset classes can move together if a common driver is the dominant mover. This realization came to investors during the global financial crisis. In turn, the most sophisticated investors are now probing beneath asset classes to try to identify which are the most important return drivers, and the extent to which a total fund is exposed to each of them.

This is still leading-edge stuff, with pioneers investigating, postulating, fact-finding, measuring and testing. It will take a long time before these ideas become mainstream, at which stage everyone will know which variants have survived and we may witness an emergence of multiple practitioners. Meanwhile, we see lists used by pioneers that vary from six basic drivers across asset classes to 17 drivers for equities alone, with little overlap among the lists. Some postulated drivers are grounded in the economy, such as inflation, real interest rates, economic growth, political risk and so on. Others are market-based, such as equity value/growth, cap size, dividend yield and volatility. Additionally, others are centered on momentum, the carry trade, merger/arbitrage – the list is far from exhaustive.