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Abstract
This article clarifies that methodological choices can be made independently for two steps in the construction of alternative equity index strategies: the constituent selection and choice of a diversification-based weighting scheme. By flexibly combining the different possible choices for these steps, the authors create a large variety of strategies and test their performance and risk results. The results suggest that diversification approaches may be a superior alternative, or at least a very important complement, to pure stock selection approaches when it comes to reaching a risk–return objective. Moreover, even though some argue that the risk and performance of diversification-based weighting schemes are solely driven by factor tilts, the authors show how straightforward it is to correct such tilts through the selection of stocks with appropriate characteristics while maintaining the improvement in achieving a risk–return objective that is due to the respective diversification approaches.
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