Investment strategies based on forecasts are (almost) useless

TL;DR

Forecast-based investment strategies are largely ineffective, as empirical evidence shows they perform no better than random or trivial approaches, questioning their practical value in portfolio management.

Contribution

The paper demonstrates that forecast-based strategies offer no significant advantage over simple or random strategies in portfolio construction.

Findings

Forecasts perform similarly to trivial or random strategies.

No substantial difference between 'best' and 'trivial' forecasts.

Forecast significance appears only under specific limited conditions.

Abstract

Several studies on portfolio construction reveal that sensible strategies essentially yield the same results as their nonsensical inverted counterparts; moreover, random portfolios managed by Malkiel's dart-throwing monkey would outperform the cap-weighted benchmark index. Forecasting the future development of stock returns is an important aspect of portfolio assessment. Similar to the ostensible arbitrariness of portfolio selection methods, it is shown that there is no substantial difference between the performances of ``best'' and ``trivial'' forecasts - even under euphemistic model assumptions on the underlying price dynamics. A certain significance of a predictor is found only in the following special case: the best linear unbiased forecast is used, the planning horizon is small, and a critical relation is not satisfied.