‘Diversification is the only free lunch in Finance’ This famous quote by Nobel laureate Harry Markowitz from 1952 revolutionized the investment industry and has lost none of its importance and relevance to this day.
According to economic theory, investors are only compensated for the non-diversifiable, systematic ‘market’ risk, but not for any individual, market specific or active portfolio risks. The resounding success of passive investment strategies in the recent decade, e.g. passive ETF vehicles, compared to active strategies seems to confirm the theory in an impressive way. But how many positions are needed in practice to take advantage of the diversification potential embedded in a specific investment strategy? At Quantica, we have recently expanded our investment universe for the Quantica Managed Futures Program (QMF) from 64 to 84 of the most liquid, global futures markets. Quantifying the diversification benefit of this expansion is, of course, one of the important tasks we had to carefully complete prior to implementing such enhancement to the strategy.