Improving the naive diversification: An enhanced indexation approach

Helong Li, Qin Huang and Baiyi Wu

Finance Research Letters, 2021, vol. 39, issue C

Abstract: This paper employs enhanced indexation to derive an optimization model with an explicit objective to track and outperform the naive diversification (1/N) strategy. The proposed model is data-driven and can start from any number of historical return samples. Simulation shows that the number of samples needed for the new model to outperform the 1/N benchmark is much smaller than the number documented in existing literature for other models. Our out-of-sample tests show that the proposed enhanced indexation model with the 1/N strategy as benchmark can achieve higher expected returns and significantly higher Sharpe ratios in most of the test cases.

Keywords: Enhanced indexation; Enhanced index tracking; Naive diversification; Portfolio management; Benchmark portfolio (search for similar items in EconPapers)
JEL-codes: C60 G10 G11 (search for similar items in EconPapers)
Date: 2021
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Persistent link: https://EconPapers.repec.org/RePEc:eee:finlet:v:39:y:2021:i:c:s1544612320302579

DOI: 10.1016/j.frl.2020.101661

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