On Portfolio Optimisation Techniques

Abstract

Here we look at alternative equity index weightings to ‘Market Capitalisation Weighting’ to see whether the expected theoretical improvement given by Portfolio Optimisation Techniques are realised in practice. We introduce a new portfolio weighting measure, called ‘Constrained Inverse Beta’, which is simple to implement and effectively a conservative combination of ‘1/N’ , ‘Minimised Variance’, and the less widely used ‘Minimised Correlation’. Choosing any of the four different weightings is a considerable improvement on market capitalisation, and this holds over all sets and subsets of data in our experimentation universe. Also, we find that the weights of the portfolio are at least as important as any single stock selection factor taken in isolation. We quantify the improvements below.

Keywords: Market Capitalization Weighting, Portfolio Optimisation

JEL Classification: G10, G11