Investors might intuitively think that indexing to a cap-weighted benchmark is a ‘neutral’ position, but for the TOBAM founder, such an approach is an implicit bet on whatever happens to be the biggest stock in the index at the time. “Market cap-weighted indexing will only reach its full potential if you get to ‘S&P 1’ or ‘ASX 1’, and the one prediction of the future I’m prepared to make is that that will not happen,” Choueifaty declares.
The Paris-based mathematician, who had to extricate his business from part-ownership by Lehman Brothers in 2008, has come up with a concept called the ‘Anti-Benchmark’. Its beta is simply diversification, which Choueifaty says produces the equity risk premium in a purer form than the market-based portfolio can ever hope to. The A-B considers nothing but volatility and correlation, to arrive at what Choueifaty calls “the most diversified portfolio possible”. One might think this would mean TOBAM’s global equity portfolio would include hundreds of equally weighted stocks – in fact, it has 62 only.
“But they are the 62 stocks whose only similarity is that they are part of my benchmark – in every other way, they are as different as it is possible to be.” Needless to say, TOBAM is not an outperformer when a single factor is driving the stockmarket, the most famous recent example of which is the late 1990s technology boom. However, backtesting of the Anti-Benchmark shows it would have outperformed during the tech wreck, because the worst falls were in a concentrated set of factors, and during the recovery too, because the A-B had naturally maintained its weighting to value, which rebounded most strongly.
And while Choueifaty wouldn’t be caught dead trying to guess “the next big thing”, he reckons he’ll always have a decent exposure to it when it comes, simply because the A-B portfolio will never be concentrated in something else.