Title: Performance of equal weight strategies using fewer assets
Authors: Anna-Katharina Thoes - TU Kaiserslautern (Germany) [presenting]
Joern Sass - University of Kaiserslautern (Germany)
Abstract: Diversification is one of the main pillars of investment strategies. The prominent 1/N-portfolio, which puts equal weight on each asset, is apart from its simplicity a method which is hard to outperform in realistic settings. But depending on the number of considered assets this method can lead to very large portfolios. We investigate how the number of assets can be reduced and which advantages and disadvantages arise with such a reduction. Therefore we investigate different naive portfolios from selecting the best Sharpe ratio assets to exploiting knowledge about correlation structures using clustering methods. The clustering techniques separate the possible assets into non-overlapping clusters and the assets within a cluster are ordered by their Sharpe ratio. Then the best asset of each portfolio is chosen to be a member of the new portfolio with equal weights, the cluster portfolio. We show that this portfolio inherits the advantages of the 1/N-portfolio and can even outperform it empirically. We finally derive corresponding results in comonotonic model settings for the clusters, and show how they can explain our observations on real data.