The portfolio recommendation is based on two low-volatility strategies: a long-only minimum-variance portfolio and a “130:30” minimum-variance portfolio, which is long 130% and short 30%.
These strategies use advanced Optimization and Statistics techniques to hedge against the estimation risk of the associated models. As a result, they attain consistently better risk-adjusted returns than market indexes, as these portfolio recommendations show.
For more details about the implementation of these strategies, please read the following post: Some efficient low-volatility portfolios: the minimum-variance policy.
The long-only and the 130:30 low-volatility portfolios recommended for this week, with their corresponding weights, can be found in this file: US_weights_20111107.csv
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 current long-only portfolio composition is very similar to that of previous quarter, except for five stocks sold (out of 24). The turnover is 22% (due to the portfolio growth and the trading of these five companies). On the other hand, the turnover of the current 130:30 portfolio is a bit larger: 26%.Regarding the performance, over the last year (52 weeks), the long-only strategy attained a volatility of 10.6% (versus 19.3% of the S&P 500). The volatility of the 130:30 strategy is even better: 8.9%.
The weekly 95%-VaR of the long-only portfolio was 2.2% (versus 4.6% of the S&P 500). The corresponding VaR for the 130:30 portfolio was 1.9%.
The last year annualized Sharpe ratio of the long-only strategy was 1.36 (after proportional transaction costs of 40 bps were discounted). On the other hand, the SR of the 130:30 strategy was 1.70. Finally, the SR of the S&P 500 was 0.39 over the same period.
In the next figure, you can see the compounded return over the last 52 weeks of the three considered portfolios.
Both low-volatility portfolios attain better returns than those of the S&P 500.
But let add information about the risk. The next graph shows the risk-return space for the three considered portfolios.
The red point represents the mean return and volatility of the long-only portfolio over the past 52 weeks. On the other hand, the green point represents the 130:30 portfolio, and finally the blue point represents the S&P 500 index over the same 52 past weeks.
We can see the two low-volatility portfolios have better mean returns than that of the S&P 500, and also their volatilities are better. In this case, we say the low-vol portfolios dominate 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 long-only and 130:30 portfolios attained a higher return than that of the S&P 500 (83% and 48% of the time, respectively). Moreover, the volatility of both low-vol portfolios was always less than that of the S&P 500.
As a summary, the low-volatility strategies dominate the market index most of the time, showing they attain consistently better risk-adjusted returns.