3 - Applications of portfolio variety

Abstract

Investment managers spend large amounts of time and money to assess the potential volatility of their portfolios, as measured by the time series variation in the returns. However, the asset management mandates of most institutional investors focus on returns relative to some benchmark index. The concept of variety has many important uses in investment management practice. Among these is to provide a means of estimating with the correlations among a set of assets with much more limited data than is possible by the usual time series analysis. Another important use of variety is to improve the statistical robustness of the analysis of a manager's past performance by adjusting for the changing levels of volatility in the market. The concept of variety also plays other important roles with respect to active management of equity portfolios. One intriguing possible usage for variety is in characterization of active equity management styles. Such approaches to active equity management are described as being oriented toward “value,” “growth,” or “momentum.” As long as the practice of measuring investment returns on a benchmark index, relative basis is prevalent, the cross-sectional dispersion or variety of returns is of paramount importance to investors.