TOBAM’s Choueifaty diversifies to beat benchmarks

TOBAM founder Yves Choueifaty talks about winning over the world’s toughest clients by challenging the benchmark investment model.

Yves Choueifaty, founder of Paris-based asset manager TOBAM, believes diversification is “magic”.

He is therefore aiming high, striving to provide investors with the most diversified equities portfolio in existence.

As he explains: “Very early in our life at TOBAM, we realised that everybody talks about diversification. But funnily enough, it has never been well-defined. Every ­portfolio manager knows how to measure volatility, tracking error, alpha, beta, gamma, delta, but there is no measure of diversification.”

Choueifaty has set out to define the elusive notion of maximum diversification via a systematic quantitative methodology that avoids the concentration risk associated with market cap-weighted indices.

Simultaneously, his model aims to deliver stable performance across market cycles while capturing the full risk premium available for a given asset class.

He is frustrated that investors still cling to ­benchmark investing, but concedes this happens for two reasons.

First, benchmarks are a convenient way of ­measuring ­performance and risk. Second, theoretical ­support in the past has led some investors to believe benchmark indices are efficient.

Choueifaty refers to the work of William Sharpe, who won a Nobel Prize in 1990 for developing a general theory for the pricing of financial assets.

According to Choueifaty, Sharpe identified the assumptions that needed to be true in order for a benchmark to be efficient and noted that these assumptions were highly unrealistic.

“Unfortunately, everybody has forgotten about the assumptions and taken for granted the fact that benchmarks are efficient,” he laments.

Choueifaty believes market cap-weighted benchmarks lack efficiency as they concentrate on the sectors that best performed in the past.

He says history proves that benchmarks often allocate a lot of risk to technology, media and telecoms (TMTs); oil companies; or financial stocks.

The better those sectors perform, the more the benchmarks increase their risk allocations to them. 

Buying market cap-weighted benchmarks is therefore fundamentally flawed, he adds, as this equates to ­predicting that the market cap of the dominant companies at the top of the benchmark will continue to grow.

“You will always culminate risk allocation to those s­ectors at exactly the worst moment. If you carry 40% of TMTs in your portfolio, to justify this risk allocation you need to become more bullish on TMTs and forecast that the 40% will go to 42%.

“The day it goes to 42%, you will be even more bullish than the day before. This means that when you buy the index in the long term, you are forecasting that ­concentration will go to one – that the S&P 500 will ­disappear, and will be replaced by the S&P 1.” 

Rewriting the rules

To combat the concentration risk typical of these ­benchmarks, Choueifaty has developed a mathematical measure of a portfolio’s diversification, aptly named the Diversification Ratio.



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