Portfolio Weighting Methods: Naïve vs. Scientific Diversification

Abstract

In our study we found that picking the right weighting method at times doubles portfolio returns. But, paradoxically, we found no significant differences between returns achieved through naïve and scientific weighting methods. Nevertheless, we dismissed the hypothesis that portfolio weightings are irrelevant, since we found a set of variables explaining their relative performance. Our conclusion is that passive investors will gain from sticking to weighting methods based on the marginal efficiency of equity or capitalization rather than the widely advocated mean-variance method. However, active investors can gain from portfolio re-balancing based on one or multiple weighting methods.

Keywords: portfolio diversification, weighting methods, performance attribution, active and passive investing

JEL Classification: G11, G00, M40