The firm says that means investors have to think about ways to protect themselves beyond just options, which they can work in the short term, but have a high price and weaker track record in the long run.
But this isn't just a game. Those two types of downturns require different defenses, and AQR argues that investors who are trying to protect themselves against the next market crash might be leaving themselves vulnerable to something worse. "As we look at 'long-term' horizons, the value and consistency of options deteriorates, as the insurance premium tends to eat away at returns," they wrote. "Insurance strategies with the biggest wins in crash months are likely ones that in good times lose all or most of the capital allocated to them."
Over a longer time frame, however, it doesn't build on that edge very much. In a 10-year downturn, its all-defense portfolio outperforms by a little more than 15%.Meanwhile, a risk parity approach would diversify an investor's portfolio away from stocks and add other assets like commodities, currencies, and credit.
It then offers two ways to invest in those alternatives. One is to bet on a range of styles such as value, momentum carry and defense. Over the course of a year, that approach would beat a 60-40 portfolio in a bad market by about 20%, and that advantage would increase over time, hitting 60% after three years and 120% over a decade.
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