Saturday, April 30, 2011

US weekly portfolio recommendation (from 2, May 2011)

The low volatility portfolio recommended for this week is (ticker notation):

    'MO'    'AMGN'    'BCR'    'BDX'    'CVS'    'CPB'    'CLX'    'ED'    'EW'   
    'FDO'    'GIS'   'HRL'    'JNJ'    'K'    'KMB'    'MKC'    'MCD'    'PEP'   
    'PG'    'RAI'    'SO'    'WEC'
Although I recommend a portfolio composition every week, it is desirable to maintain this composition for several weeks (for instance a quarter year), and then rebalance with the new composition.
The portfolio composition is the same as that of previous quarter. For this reason, the turnover is only 4% (due to the portfolio growth).
Regarding the performance, over the last year (52 weeks), the strategy attained a volatility of 10% (versus 17% of the S&P 500).

The weekly 95%-VaR was 2.4% (versus 4.2% of the S&P 500).

The last year annualized Sharpe ratio of the low-vol strategy was 1.77 (after proportional transaction costs of 40 bps were discounted). On the other hand, the SR of the S&P 500 was 0.75 over the same period.

The next graph shows the risk-return space for the two considered portfolios.

The red point represents the mean return and volatility of the low-vol portfolio over the past 52 weeks. On the other hand, the blue point represents the mean return and volatility of the S&P 500 index over the same 52 past weeks.

We can see the low-vol portfolio has a better mean return than that of the S&P 500, and also its volatility is better. In this case, we say the low-vol portfolio dominates the index.

I have computed the same risk-return space for every week over the last year, using the same 52-weeks historical method to estimate the mean returns and the volatilities. The low-vol portfolio attained a higher return (79% of the time) than that of the S&P 500. Moreover, the volatility of the low-vol portfolio was always less than that of the S&P 500.

As a summary, the low-volatility strategy dominates the market index most of the time, showing it attains consistently better risk-adjusted returns.


  1. What an excellent site!
    Your work is interesting, practical and easy to follow. Excellent writing (in English). Thanks much.

    Have you ever thought of using the Implied Volatility of long date (American) options for the variance? Some work has been done that shows option IV close to forecasted standard deviations of monthly returns. Again, thanks and I look forward to all your future posts.
    Jim Kerns

  2. Jim,

    Thank you very much for your comments. I have read some papers about that topic, although I didn’t try those ideas in my experiments.

    Let me reference here two related papers:

    Implied Volatility Spreads and Expected Market Returns

    Improving Portfolio Selection Using Option-Implied Volatility and Skewness