Best Weighting Scheme for Top Stocks?
June 7, 2016 - Strategic Allocation
How hard is it to beat equal weighting in constructing a portfolio of attractive common stocks? In his May 2016 paper entitled “Naive Diversification Isn’t so Naive after All”, Mike Dickson compares performances of 15 portfolio construction methods applied to eight portfolios of stocks with high expected returns. Construction methods include equal weighting, two versions of minimum volatility, three versions of mean-variance optimization, eight versions of reward-to-risk timing (six of which involve factor models) and a characteristic-based scheme that each year estimates stock weights based on market capitalization, book-to-market ratio, gross profitability, investment, short-term reversal and momentum. The eight portfolios consist of stocks with the top 10% or top 20% of expected returns based on rolling averages of multivariate cross-sectional regression coefficients for these same characteristics, formed with or without momentum and with or without microcaps (capitalizations less than the 20% percentile for NYSE stocks). He estimates trading frictions as 1% of the value traded each month in rebalancing to specified portfolio weights. Using monthly data for a broad sample of U.S. common stocks during July 1963 through December 2013 (with evaluated returns commencing July 1973), he finds that: Keep Reading