Lessons on Risk, Return, and Portfolio Construction from the Great Investors

There is often a wide divergence between academic and practitioner views on risk, return, and portfolio construction. For example, academics focus primarily on purely quantitative measures or factors. Initially, the focus was on dividends, free cash flow, standard deviation, and beta. Later, additional factors analyzed by the academic community came into focus, such as size, style, liquidity, momentum, and quality. Practitioners, in contrast, often focus on a company’s products, its history, and the competitive dynamics of its industry. Furthermore, practitioners “discovered” anomalies, such as momentum, decades before they were rigorously analyzed and published by academics. The current distinction between the two groups is not merely quantitative versus qualitative. This chapter summarizes the viewpoints of the two camps — academic and practitioner — and suggest steps that may effectively combine the two schools of thought, at least to a certain degree using the Black–Litterman model and other qualitative techniques, such as stratifying asset pricing models. This analysis may result in a more robust investment, risk management, and portfolio construction process.