### MPT Cannot Beat Equal Weight?

**April 15, 2013** - Strategic Allocation

Why do optimal portfolios derived from Modern Portfolio Theory (MPT) often lose to simple equal-weight portfolios? In the March 2013 version of their paper entitled “Why Optimal Diversification Cannot Outperform Naive Diversification: Evidence from Tail Risk Exposure”, Stephen Brown, Inchang Hwang and Francis In explore why mean-variance optimal diversification (giving more weight to those assets driving mean-variance efficiency) do not outperform naive diversification (equal-weight). They consider portfolios formed from each of two sets of assets: (1) factor-based sorts of U.S. stocks (effectively equity style indexes); and, (2) individual U.S. stocks. Unlike prior research, they focus on return distribution tail exposures of test portfolios rather than errors in forecasts of mean returns and return covariances for assets used to construct optimal portfolios. They rebalance competing portfolios monthly. For mean-variance optimization, they use a 10-year rolling history to forecast required parameters. They evaluate both long-short and long-only mean-variance optimal portfolios. Using monthly returns for 20 factor-based U.S. stock sorts from Ken French’s library and for a broad sample of individual U.S. stocks during January 1963 through December 2011 (588 months), *they find that:* Keep Reading