Naive Diversification Isn't So Naive After All

52 Pages Posted: 19 May 2016

See all articles by Mike Dickson

Mike Dickson

Horizon Investments; University of North Carolina at Charlotte

Date Written: May 18, 2016

Abstract

I conduct a horse-race of 15 portfolio construction techniques over 8 empirical datasets comprised of individual stocks. I also conduct a robust Monte Carlo analysis that confirms that recent extensions of mean-variance optimization due to Kirby and Ostdiek (2012) are successful in curbing estimation risk and turnover. Despite these facts, my results indicate that no strategy consistently outperforms naive diversification in terms of mean excess return, Sharpe ratio, and turnover. I introduce a statistic, the time series average of the cross-sectional mean absolute deviation of risk and return, to explain why I observe these results. Data limitations and dataset characteristics contribute the most to the performance of a candidate strategy. I also propose several extensions to active timing strategies and include new characteristics in a parametric portfolio choice framework. Naive diversification continues to prevail, suggesting practical optimization techniques are inferior to naive diversification when forming portfolios of individual stocks.

Keywords: active management, stock-picking, portfolio optimization

JEL Classification: G11, G12, G17, C13

Suggested Citation

Dickson, Mike, Naive Diversification Isn't So Naive After All (May 18, 2016). Available at SSRN: https://ssrn.com/abstract=2713501 or http://dx.doi.org/10.2139/ssrn.2713501

Mike Dickson (Contact Author)

Horizon Investments ( email )

Charlotte, NC
United States
7049193611 (Phone)
7049193611 (Fax)

HOME PAGE: http://www.horizoninvestments.com/

University of North Carolina at Charlotte ( email )

9201 University City Boulevard
Charlotte, NC 28223
United States

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