Next Boston QWAFAFEW Meeting: Tuesday, 21 Apr 2015
Time: 6:15 PM sharpe
3rd Floor of the Tennis & Racquet Club, 939 Boylston Street
RSVP to hugh@QWAFAFEW.org
The Triumph of Mediocrity: A Case Study of “Naïve Beta”
A QWAFAFEW discussion arranged by John Minahan and led by:
Edward Qian, PhD
In contrast to factor-based “smart beta”, diversification-based “smart beta” assumes that, seemingly “naively”, all investments are just average or the same in some dimension. The four possible dimensions: portfolio weight, expected return, risk-adjusted return, and risk contribution, lead to four “naïve beta” portfolios respectively: equal-weight, minimum variance, maximum diversification, and risk parity portfolios. In this paper, we show how these four portfolios outperform the capitalization-weighted S&P 500 index due to their sector differences and especially, the index’s aggressive shifts into specific sectors. Among the three “naïve beta” portfolios that use risk inputs as part of their portfolio construction, both minimum variance and maximum diversification portfolios tend to be highly concentrated in certain sectors. We develop an analytic framework based on a partitioned correlation matrix, modeling sectors as two groups (mostly defensive versus cyclical). The results shed light on material differences between the risk parity and optimized portfolios in their level of diversification across the sector and stock dimensions. Empirical examples of sector and stock portfolios within the universe of the S&P 500 index show the triumph of “naïve beta” over the index, which suffers from strong sector biases and ill-timed allocation shifts.
Edward Qian is the Chief Investment Officer and Head of Research, Multi Asset at PanAgora Asset Management in Boston. Dr. Qian has a B.S. in mathematics from Peking University and a Ph.D. in applied mathematics from Florida State University. He was a postdoctoral researcher at the University of Leiden and a National Science Foundation Postdoctoral Research Fellow at MIT.
Dr. Qian’s investment research has been extensive. His papers on risk budgeting and asset allocation laid the theoretical foundations for Risk Parity investment strategies. Dr. Qian coined the term “Risk Parity” in 2005 His research on quantitative equity has been equally influential. Dr. Qian is a co-author (with Ronald Hua and Eric Sorensen) of the book “Quantitative Equity Portfolio Management: Modern Techniques and Applications”. He is the recipient of Bernstein Fabozzi/Jacobs Levy awards for outstanding articles.
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