Click to login and read the full article.
Don’t have access? Click here to request a demo
Alternatively, Call a member of the team to discuss membership options
US and Overseas: +1 646-931-9045
EMEA: +44 0207 139 1600
Abstract
The authors compare two approaches to single-factor index design: concentrated and diversified indices. From a conceptual perspective, the authors emphasize several issues with highly concentrated portfolios. Concentration in a few stocks reflects high confidence in the precision of the link between expected returns and factor exposure, whereas expected returns are notoriously difficult to estimate precisely. Moreover, the empirical asset-pricing literature emphasizes the need to construct broad portfolios that are not unduly influenced by a small number of stocks. The authors’ empirical analysis compares broader and more narrow stock selections, as well as two different weighting schemes, equal-weighting and cap-weighting. Their results show that concentrated factor-tilted portfolios come with problems. Trying to improve a cap-weighted factor-tilted portfolio’s performance by selecting fewer stocks that are most strongly tilted to the factor does not have any effect on risk-adjusted performance. With concentration, returns and risk increase. However, concentration leads to problems such as higher turnover, high idiosyncratic risk, and longer times to trade. Conversely, achieving concentration through a move to equal-weighing leads to higher Sharpe and information ratios, with only marginally higher turnover levels.
- © 2016 Pageant Media Ltd
Don’t have access? Click here to request a demo
Alternatively, Call a member of the team to discuss membership options
US and Overseas: +1 646-931-9045
UK: 0207 139 1600