Diversification, volatility, and surprising alpha

Banner, Adrian, Fernholz, Robert, Papathanakos, Vassilios, Ruf, Johannes ORCID: 0000-0003-3616-2194 and Schofield, David (2019) Diversification, volatility, and surprising alpha. Journal of Investment Consulting, 19 (1). 23 - 30. ISSN 1424-6035

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Abstract

It has been widely observed that capitalization-weighted indexes can be beaten by surprisingly simple, systematic investment strategies. Indeed, in the U.S. stock market, equal-weighted portfolios, random-weighted portfolios, and other na¨ive, nonoptimized portfolios tend to outperform a capitalization-weighted index over the long term. This outperformance is generally attributed to beneficial factor exposures. Here, we provide a deeper, more general explanation of this phenomenon by decomposing portfolio log-returns into an average growth and an excess growth component. Using a rank-based empirical study we argue that the excess growth component plays the major role in explaining the outperformance of na¨ive portfolios. In particular, individual stock growth rates are not as critical as is traditionally assumed.

Item Type:	Article
Official URL:	https://investmentsandwealth.org/journalofinvestme...
Additional Information:	© 2019 Investments & Wealth Institute, formerly IMCA
Divisions:	Mathematics
Subjects:	H Social Sciences > HG Finance
Date Deposited:	26 Jun 2019 15:09
Last Modified:	01 Oct 2024 03:05
URI:	http://eprints.lse.ac.uk/id/eprint/101070

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