I came across an interview with Jordan Brooks, who runs macro strategies at AQR Capital Management, in the Journal of Portfolio Management. AQR manages somewhere around $100 billion. Brooks has a PhD, teaches at Yale and NYU, and spends his days thinking about global macroeconomics in ways that would make most people’s heads spin.
You are probably not Jordan Brooks.
But that doesn’t mean there’s nothing in here for you.
Here are a few things that stuck with me.
“The first lesson was from day one of freshman economics—casting economic problems in terms of objectives, alternatives, and constraints is a very powerful organizational framework. The second lesson came through lived experience working with clients over my professional career at AQR—investors can often make better decisions by simplifying objectives, expanding the universe of potential alternatives, and relaxing or eliminating unnecessary and overly binding constraints.“
Jordan starts talking about “simplifying objectives” and my mind goes straight to goal-based investing. Break your life into chapters, each with its own portfolio. Simple, right?
Here’s what actually happens. You build the plan. Then you get fired —> rebuild. Your relationship ends and your new partner doesn’t want kids —> rebuild. Promotion but you have to relocate —> rebuild. Surprise pregnancy —> rebuild. Life doesn’t move in a straight line toward clearly labeled goals. And yet goal-based investing asks you to pin a specific mini-portfolio to each lurch. That’s not simplifying anything. That’s complexity (with better marketing). And the returns don’t even compensate you for the effort.
It’s also a self-imposed constraint. “Stocks for growth, bonds for safety.” We’ve spent a lot of time here explaining why bonds aren’t actually that safe. But the bigger issue is that goal-based buckets have no home for gold, managed futures, commodities, market-neutral strategies. They get shuffled into the retirement bucket, the one that’s officially long-term but in practice becomes a miscellaneous drawer. And leverage? Don’t even start. The moment you mention it someone says “that’s how people blow up.”
Expanding the investment universe requires work, but it’s a one-time cost. Once you genuinely understand what role gold plays in a portfolio, for example, that knowledge is yours forever. Most retail investors skip these asset classes not because they’ve studied them and decided they don’t work, they skip them because they never did the homework. That’s a meaningfully different thing, even if the portfolio looks identical.
There’s an inflection point where ignoring certain asset classes stops being a personal choice and starts dragging on your returns, even if you never touch those assets. If the market figures out that A plus B makes A less risky, it bids up A. If you only own A, your risk-adjusted returns quietly degrade. You didn’t do anything wrong. You just fell behind.
At first it’s “I don’t need to be optimal.” Fine. But eventually that quietly becomes “how did I fall so far behind?” The gap doesn’t announce itself. It just compounds.
“The aim of the SAA is to maximize risk-adjusted expected returns.“
Nothing simpler than this: maximize REAL, risk-adjusted expected returns. Do it, and it takes care of everything else.
I’d add one thing Jordan touches on differently. The reason this objective matters so much, particularly for retail investors, is precisely because the classic stock and bond portfolio is so bad at it.
Bad at real returns, because stocks and bonds both struggle when inflation runs hot. Bad at risk-adjusted returns, because stocks and bonds are correlated enough in some bad environments that the diversification you think you’re getting is less than advertised.
You have one job: make sure your money grows faster than inflation, with as little unnecessary risk as possible, for as long as possible.
The classic portfolio isn’t built for that job. It’s just the easiest one to explain.
“While over decade-long periods any one asset class may significantly outperform, over longer samples risk-adjusted returns of different asset classes (e.g., stocks, bonds, commodities) are similar.“
Useful reminder for anyone who wrote off bonds simply because of how they’ve performed lately. But “bonds have been bad recently” is not the same argument as “bonds are structurally broken forever.” If high inflation becomes a persistent feature of the next decade, fine: that’s a legitimate case against them. But how many people making that call can actually do that analysis reliably? Most are just pattern-matching off recent pain.
The flip side is equally worth saying out loud: stocks have spent the last two decades running at roughly double their historical Sharpe ratio. A lot of investors are now “comfortable” with stocks in a way that has almost nothing to do with understanding stocks: it’s just that stocks have been unusually kind. That’s not the same as having real risk tolerance. It’s having experienced an unusually forgiving environment and mistaking it for courage.
“Asset class Sharpe ratios that are more similar than different, coupled with low correlations across asset classes, imply the optimal SAA should have a good chunk of risk coming from different asset classes. … This simple exercise produces an SAA that is meaningfully different from most traditional asset allocations.“
In other words, stocks and bonds are not enough. We will see later why.
“we find it is important to separate inflation into two components: core inflation and food and energy inflation (which together sum to headline inflation). It turns out asset classes may have quite different sensitivities to core and food/energy inflation shocks. Nominal bonds are negatively exposed to both. Equities are negatively exposed to core inflation but hold up well in food/energy inflation. Commodities are often considered an inflationary hedge, but a caveat applies. Historically they’ve been an excellent hedge against food/energy inflation but not core inflation.“
If you don’t understand the different sensitivities of your assets, you will get surprised. Stocks dive because core inflation runs hot…wait, weren’t commodities supposed to help? Stocks hold up fine during an oil spike…wait, wasn’t inflation bad for equities? Rules of thumb are useful. They save mental bandwidth. But they’ll push you off balance the moment you apply them outside the conditions they were built for. Knowing when a heuristic applies is most of the work.
Here’s a concrete example. A core inflation spike hits a stock-bond-commodities portfolio harder than people expect. That’s why my third leg of the stool is trend following rather than commodities. Trend following has meaningfully higher expected real returns than inflation-linked bonds, and a much better volatility profile: IL bonds only give you downside volatility, no real upside kicker. Trend following earns its keep across a wider range of environments.
But here is the honest caveat: it’s a more complex strategy than buying a bond ETF, and it carries real manager and model risk. You’re not just buying an asset class, you’re buying someone’s implementation of an idea. That risk can be managed by spreading exposure across multiple strategies or products within the same sleeve rather than concentrating in one fund.
“Not all alternatives are created equal—with respect to their diversification properties, their liquidity, and their transparency.“
The rule of the game is simple: diversify your diversifiers.
The key variable is correlation. Stocks, volatility risk premium, and corporate credit spreads are highly correlated…but not perfectly. That imperfect correlation is where the opportunity lives. You can hold VRP in a portfolio, as long as it partially displaces stocks rather than sitting on top of them as a separate addition. It earns its seat by doing a similar job with slightly different timing.
Is that level of complexity worth it for you personally? Maybe not. There’s no shame in deciding the juice isn’t worth the squeeze. Even if you ultimately stick with a simple three-asset class portfolio, knowing where each building block would theoretically sit — what it correlates with, what it replaces, what environment it thrives in — makes you a more clear-eyed investor. You stop wondering why everything is falling at the same time. You stop being surprised that your “diversified” portfolio moved as one during the 2020 crash or in late 2022.
The map doesn’t have to be complicated. But you should have one.
“Our positions and trades are determined by heavily researched and backtested algorithms. This does not mean, however, that our investment process is devoid of discretion. Our discretion manifests in the design of the models. For SAA, what are our objectives, alternatives, and constraints? How much do we weigh having the best empirical Sharpe ratio based on historical correlations against having balanced performance across macroeconomic regimes?“
Two investors can buy into the diversified-and-levered portfolio idea completely and still land in very different places. Different ingredients, different strategic asset allocations.
That’s not a bug, that’s how markets work. There are buyers and sellers because not everyone wants the same thing. Some investors are comfortable with equity long/short. Others gravitate toward commodity carry, or get access to it through their platform. The universe of reasonable portfolios is wider than most people think.
Objectives matter just as much as ingredients. Maximizing CAGR should stay front and center, but investors have different risk appetites, usually expressed as a target volatility (or Ulcer Index, or a combination of indicators), and different liquidity preferences. A retiree drawing down and a 35-year-old accumulating have genuinely different problems to solve.
Then there’s the input problem. Sharpe ratios, or better Sortino ratios, are only as good as what you feed them. Historical returns, estimated returns, realized volatility, forecast correlations: change the inputs and you change the output. Two rational, well-informed investors optimizing for the same objective can end up with meaningfully different portfolios just because they made different assumptions about the future.
We’re optimizing for a stochastic future we’ll never fully see. You will never know with certainty if you made the right call.
That’s exactly why equal weight or equal risk or equal quadrant exposure…anything equal…tends to be a great choice. Not because it’s optimal. Because it’s robust. And because it’s a lot better for your mental health than endlessly second-guessing a model that was always just an educated guess anyway.
“In SAA, the impact of new data and ML/AI-driven tools is modest. As we’ve discussed, the primary inputs in SAA are estimates of long-run expected risk-adjusted returns, correlations, and macroeconomic sensitivities. Alternative datasets and natural language processing do not directly address these inputs.“
This is actually great news if you’re a retail investor.
A well-diversified portfolio already puts you close to the technological cutting edge. The marginal gains from more sophisticated optimization (better models, fancier inputs, more precise rebalancing) are real but small. Once you’ve found your strategic asset allocation, 90% of the job is done.
The other good news: no fancy hedge fund is coming to eat your lunch. “volatility is the price of admission” and these diversified SAA are too volatile for HF, they will never be “crowded”. Sit patient, eat your volatility and earn your gains.
“While modest underperformance of a risk-balanced SAA during bull markets can be frustrating, a multiyear capital loss from a large equity drawdown (e.g., the GFC or tech bust) in a traditional portfolio can be catastrophic.“
That’s why it is possible: it is frustrating most of the time. But this is also why I do it: because I want to avoid catastrophic results.
“Asset correlations are highly fluid, and rare or novel events can prompt co-movements that have not been observed previously. This is where you need humility. … However, a robust portfolio design and investment process can help you reduce portfolio sensitivity to correlation misestimation.“
In a traditional recession, bonds rescue stocks. In a prolonged non-choppy trend, trend following works. When stocks crash hard, volatility spikes and tail strategies earn their keep. Correlations shift over time, nothing is set in stone, but these structural relationships are durable enough to build on.
A good strategic asset allocation won’t save you from the first 20% drawdown. That’s just the price of being invested. What it does is eat almost everything after that. The difference between a max drawdown of 20% and one of 50% is not just a number: it’s the difference between an uncomfortable year and a permanently impaired portfolio. It’s the difference between staying invested and panic-selling at the bottom. It’s the difference between recovering in two years and recovering in a decade, if at all.
Most investors focus on upside. The real work happens on the downside.
“If you maintain constant exposure, you may be forced to sell parts of your portfolio at a bad time (a fate many investors endured during the GFC). I think this point is generally appreciated and motivates various drawdown control mechanisms. A less appreciated point, however, is that a portfolio with time-varying risks, even if you can hold it over the long term, isn’t optimal either. Time-varying volatility reduces risk-adjusted returns, so your long-term returns will come disproportionately from stressful environments. A prudent SAA will aim to target a relatively constant level of volatility over time. The benefits aren’t just that such a portfolio is easier to hold in stress environments, but that long-term returns aren’t driven by the handful of periods when market volatility was high.“
This part doesn’t get enough attention.
Even if you somehow hold your nerve through a 50% drawdown with a 100% stock portfolio, a huge chunk of your returns will come from the period right after the bottom. Your actual CAGR depends not just on being invested, but on when your money was in the market. If your portfolio is funded by a salary, the same shock that crushes stocks probably threatens that salary too. You’re most exposed exactly when you’re most vulnerable.
And if you’re retired and drawing down? Now you’re selling into the crash to fund your spending. The sequence kills you even if the long-run average looks fine on paper. Swap the stock crash for three years of 10% inflation and a stock-bond portfolio gets hit just as hard, just differently.
Here’s the volatility problem nobody talks about clearly enough. A 100% stock portfolio has roughly 17% long-term volatility. But that number is a lie of averages. Most of the time stocks run at around 5% volatility. During crashes it jumps to 40%. A well-diversified portfolio targeting the same 17% experiences something close to 17% consistently.
That difference is also why diversified investors get frustrated. Most of the time they’re sitting at 17% volatility watching the all-stock crowd cruise at 5%, wondering why they bothered with all the complexity. The diversified portfolio looks unnecessarily cautious in calm markets and brilliantly constructed in chaotic ones.
The problem is we spend most of our time in calm markets. Until we don’t.
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