How Optimal are Risk-based Portfolios?

Journal of Portfolio Management, forthcoming

Posted: 22 Jul 2020 Last revised: 10 Sep 2023

See all articles by Redouane Elkamhi

Redouane Elkamhi

University of Toronto - Rotman School of Management

Jacky S.H. Lee

Healthcare of Ontario Pension Plan Trust Fund

Marco Salerno

Healthcare of Ontario Pension Plan Trust Fund

Date Written: June 30, 2020

Abstract

Since the early 2000s, interest in risk-based rules has grown as the asset management industry adopted these allocation methods to maximize diversification benefits, with the hope of achieving better out-of-sample performance compared to traditional methodologies (e.g., mean-variance). The theoretical optimality of risk-based portfolios is often an afterthought. In this article, we suggest that perhaps their theoretical optimality warrants increased attention especially given their common acceptance. We provide the necessary and sufficient conditions for a class of risk-based rules (e.g., inverse volatility portfolios) to be considered theoretically optimal in a mean-variance framework, and we show that such conditions are met empirically using many common datasets. This finding supports the empirical observation that these portfolios outperform out-of-sample both mean-variance and equally weighted portfolios. Our results suggest that risk-based rules have merits from the perspective of optimality, beyond their robust characteristics.

Keywords: Portfolio Choice, Asset Allocation

JEL Classification: G11

Suggested Citation

Elkamhi, Redouane and Lee, Jacky and Salerno, Marco, How Optimal are Risk-based Portfolios? (June 30, 2020). Journal of Portfolio Management, forthcoming, Available at SSRN: https://ssrn.com/abstract=3638713 or http://dx.doi.org/10.2139/ssrn.3638713

Redouane Elkamhi

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada

Jacky Lee

Healthcare of Ontario Pension Plan Trust Fund ( email )

1 York Street
Toronto, Ontario M5J0B6
Canada

Marco Salerno (Contact Author)

Healthcare of Ontario Pension Plan Trust Fund ( email )

1 York
Toronto, Ontario M5S 3G8
Canada

Do you have negative results from your research you’d like to share?

Paper statistics

Abstract Views
1,740
PlumX Metrics