Quant Investing in Cluster Portfolios

18 Pages Posted: 12 May 2021

See all articles by Ali Akansu

Ali Akansu

New Jersey Institute of Technology

Marco Avellaneda

New York University (NYU) - Courant Institute of Mathematical Sciences; Finance Concepts LLC

Anqi Xiong

New Jersey Institute of Technology

Multiple version iconThere are 2 versions of this paper

Date Written: June 11, 2020

Abstract

This paper discusses portfolio construction for investing in N given assets, eg, constituents of the Dow Jones Industrial Average (DJIA) or large cap stocks, based on partitioning the investment universe into clusters. The clusters are determined from the trailing correlation matrix via an information theoretic algorithm that uses thresholding of high-correlation pairs. We calculate the principal eigenvector of each cluster from its correlation matrix and the corresponding eigenportfolio. The cluster portfolios are combined into a single N-asset portfolio based on a weighting scheme for the clusters. Various tests conducted on components of the DJIA and a 30-stock basket of large cap stocks indicate that the new portfolios are superior to the DJIA and other mean–variance portfolios in terms of their risk-adjusted returns from 2009 to 2019. We also tested the cluster portfolios for a larger basket of 373 Standard & Poor’s 500 components from 2001 to 2019. The test results provide convincing evidence that a cluster-based portfolio can outperform passive investing.

Keywords: subspace performance; clustering algorithm; asset clusters; cluster eigenportfolios; combined portfolio of cluster eigenportfolios.

Suggested Citation

Akansu, Ali and Avellaneda, Marco and Xiong, Anqi, Quant Investing in Cluster Portfolios (June 11, 2020). Journal of Investment Strategies, Vol. 9, No. 4, Available at SSRN: https://ssrn.com/abstract=3841535

Ali Akansu (Contact Author)

New Jersey Institute of Technology ( email )

University Heights
Newark, NJ 07102
United States

Marco Avellaneda

New York University (NYU) - Courant Institute of Mathematical Sciences ( email )

251 Mercer Street
New York, NY 10012
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Finance Concepts LLC ( email )

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HOME PAGE: http://www.finance-concepts.com

Anqi Xiong

New Jersey Institute of Technology ( email )

University Heights
Newark, NJ 07102
United States

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