The Effective Number of Securities in an Active Portfolio: Why a Passive Benchmark Should Be Equally Weighted

6 Pages Posted: 29 Apr 2021 Last revised: 1 May 2021

Date Written: April 28, 2021

Abstract

If an active equity manager's task is to pick stocks from a benchmark index, then only equal weighting reflects an appropriate benchmark reflecting no prior knowledge of which stocks will outperform others. I use Shannon's entropy to formalize this idea and show how any deviation from equal weighting reflects a smaller effective number of securities than contained in the benchmark, even if each security receives some weight, an appealing notion of the stock picker's task.

Keywords: investment management, active, passive, performance

Suggested Citation

Heaton, J.B., The Effective Number of Securities in an Active Portfolio: Why a Passive Benchmark Should Be Equally Weighted (April 28, 2021). Available at SSRN: https://ssrn.com/abstract=3836117 or http://dx.doi.org/10.2139/ssrn.3836117

J.B. Heaton (Contact Author)

One Hat Research LLC ( email )

Chicago, IL
United States
(312) 257-3900 (Phone)

HOME PAGE: http://www.onehatr.com/

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