Optimal Tilts

39 Pages Posted: 22 Feb 2016

See all articles by Malcolm P. Baker

Malcolm P. Baker

Harvard Business School; National Bureau of Economic Research (NBER)

Terence Burnham

Chapman University - The George L. Argyros School of Business & Economics; Chapman University The George L. Argyros School of Business & Economics

Ryan Taliaferro

Acadian Asset Management

Date Written: February 12, 2016

Abstract

We examine the optimal weighting of four characteristic tilts in US equity markets over the period from 1968 through 2014. We define a “tilt” as a positive-Sharpe-ratio, characteristic-based portfolio strategy that requires relatively low annual turnover and a “trade” as a characteristic-based portfolio strategy that requires relatively high annual turnover and liquidity demands. Size is a tilt, because of its very low turnover; high frequency reversal is a trade. This dichotomy is necessary to make practical use of Fama-French style factor regressions. Unlike low-turnover tilts, a full history of transaction costs and an estimate of capacity is critical to determine the expected return, and hence the optimal allocation and explanatory power of trades. The mean-variance optimal tilts toward value (20%), size (26%), and profitability (23%) are roughly equal to each other and to the optimal low beta tilt (24%). The remaining 7% is allocated to bond market factors. Notably, in an apples-to-apples comparison, the low beta tilt is not subsumed by other tilts. Rather, it is the second highest of the four.

Keywords: asset pricing, valuation, market efficiency, investment management

Suggested Citation

Baker, Malcolm P. and Burnham, Terence C. and Taliaferro, Ryan, Optimal Tilts (February 12, 2016). Available at SSRN: https://ssrn.com/abstract=2735129 or http://dx.doi.org/10.2139/ssrn.2735129

Malcolm P. Baker (Contact Author)

Harvard Business School ( email )

Boston, MA 02163
United States
617-495-6566 (Phone)

HOME PAGE: http://www.people.hbs.edu/mbaker

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Terence C. Burnham

Chapman University - The George L. Argyros School of Business & Economics ( email )

Orange, CA
United States

Chapman University The George L. Argyros School of Business & Economics ( email )

Orange, CA
United States

Ryan Taliaferro

Acadian Asset Management ( email )

260 Franklin Street
Boston, MA 02110
United States

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