Market Sense and Nonsense: How the Markets Really Work (and How They Don't)

Chapter 19

Robin Hood Investing

Many years ago, I worked for a brokerage firm where in addition to being the research director, I was also the department expert on the quantitative evaluation of commodity trading advisors (CTAs). This job responsibility got me thinking about better methods for constructing multimanager funds. At one point, it became apparent to me that if all the managers had equivalent expected future performance, the return/risk ratio would be increased if the total equity were rebalanced monthly, bringing the managers back to an equal percentage allocation.1

The assumption that all managers would have equivalent future performance did not mean that such an outcome was expected literally, but rather that one could not predict anything about the relative ranking order of the future performance of the selected managers. (Although the past ranking order was certainly known, my implicit assumption was that the past ranking was a very poor indicator of the future ranking.)

The following analogy occurred to me: The assumption of equivalent performance could be thought of as monthly performance results being represented by a series of cards—each card representing one month—with each manager’s set of results corresponding to a different shuffle of the same cards. Since all managers are assumed to have the same set of monthly results (that is, the same set of cards in a different order), and since reduced variability implies increased return (see Chapter 5), it seemed ...