Capital Mobility and the Long-Run Return-Risk Trade-Offs of Industry Portfolios
63 Pages Posted: 3 Feb 2018 Last revised: 24 Sep 2018
Date Written: September 11, 2018
Capital mobility may equalize investment opportunities across industries, and further, may cause the return-risk trade-offs of industry equity portfolios to converge. We show that over a long period from 1926 to 2014, value-weighted industry portfolios based on Fama-French 5, 10, 12, 17, 30, and 49 industry classifications have Sharpe ratios that are statistically indistinguishable from each other. We further show that Sharpe ratios of industry portfolios have a mean-reversion component and that the mean reversion of industry Sharpe ratios can be attributed to cross-industry capital mobility -- industries with higher Sharpe ratios tend to have higher capital investments subsequently. Finally, we examine the performance of an investment strategy that is explicitly based on the assumption of equal Sharpe ratios across industry portfolios. Various versions of this strategy significantly outperform the market portfolio.
Keywords: Industry Portfolio, Sharpe Ratio, Maximum Diversification Strategy
JEL Classification: G11, G12, G19
Suggested Citation: Suggested Citation