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Diversification, volatility, and surprising alpha

Banner, Adrian, Fernholz, Robert, Papathanakos, Vassilios, Ruf, Johannes and Schofield, David (2019) Diversification, volatility, and surprising alpha. Journal of Investment Consulting. ISSN 1424-6035 (In Press)

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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
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: 14 Sep 2019 23:11
URI: http://eprints.lse.ac.uk/id/eprint/101070

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