Diversification, Volatility, and Surprising Alpha

17 Pages Posted: 28 Sep 2018

See all articles by Adrian Banner

Adrian Banner

Enhanced Investment Technologies, Inc. (INTECH)

Bob Robert Fernholz

Allocation Strategies, LLC

Vassilios Papathanakos

INTECH Investment Management, LLC

Johannes Ruf

London School of Economics & Political Science (LSE) - London School of Economics

David Schofield

Enhanced Investment Technologies, Inc. (INTECH)

Date Written: June 13, 2018

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 naive, non- optimized 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 naive portfolios. In particular, individual stock growth rates are not as critical as is traditionally assumed.

Keywords: Portfolio Management, Diversification

Suggested Citation

Banner, Adrian and Fernholz, E. Robert Robert and Papathanakos, Vassilios and Ruf, Johannes and Schofield, David, Diversification, Volatility, and Surprising Alpha (June 13, 2018). Available at SSRN: https://ssrn.com/abstract=3247188 or http://dx.doi.org/10.2139/ssrn.3247188

Adrian Banner

Enhanced Investment Technologies, Inc. (INTECH) ( email )

1 Palmer Square
Princeton, NJ 08542
United States

E. Robert Robert Fernholz

Allocation Strategies, LLC ( email )

1 Palmer Square
Princeton, NJ 08542
United States
609-497-0442 (Phone)
609-497-0441 (Fax)

Vassilios Papathanakos (Contact Author)

INTECH Investment Management, LLC ( email )

CityPlace Tower
525 Okeechobee Boulevard, Suite 1800
West Palm Beach, FL
United States
609-497-9505 (Phone)
609-497-0441 (Fax)

Johannes Ruf

London School of Economics & Political Science (LSE) - London School of Economics ( email )

United Kingdom

David Schofield

Enhanced Investment Technologies, Inc. (INTECH) ( email )

1 Palmer Square
Princeton, NJ 08542
United States

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