Posts by Wesley R. Gray, Ph.D.



How many stocks should you own? The costs and benefits of Diversification

September 9, 2014

In this post we explore the trade-off between diversification and alpha generation. Here is a high level summary of the situation: Owning more stocks in a portfolio lowers "idiosyncratic" risk, or risk that can be eliminated through diversification...however...Owning more stocks dilutes performance of an "alpha" generating process. (e.g., forcing Warren Buffett to hold a 500 stock equal-weighted portfolio would dampen his alpha). In summary, fewer stocks in a portfolio imply more expected alpha and more idiosyncratic risk; more stocks in a portfolio imply less expected alpha and less idiosyncratic risk. But what is the optimal trade-off between alpha and idiosyncratic risk? Do we want to own a 1 stock portfolio? A 50 stock portfolio? A 1000 stock portfolio?

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Momentum Investing: Ride Winners and Cut Losers. Period.

July 16, 2014

Momentum has historically been a great strategy. Although counter-intuitive to many value investors, buying stocks with rising prices has been a great investment approach--arguably better than value investing. Moreover, the approach is robust between the 2 samples analyzed. The lesson is clear: Let your winners ride and cut your losers short.

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How to Build Expected Return Forecasting Models

July 14, 2014

Investors are enamored with various investment houses and personalities who claim insight into the prospects for long-term expected market returns. Some classic examples include Nouriel Roubini, John Hussman, David Rosenberg, or Jeremy Grantham. All really smart people. But have you ever asked "How" these folks came to their conclusions? In most cases, the answer is probably "No" and the reason is because there is a lack of transparency from the author(s) and/or a lack of knowledge/understanding on behalf of the reader. We also want to highlight that one can develop incredibly complex return forecasting models -- super sexy, super interesting, super compelling, etc. -- but that still doesn't mean they are any good at forecasting much of anything.

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