Abstract
Recent papers show that, due to estimation errors, existing and rather advanced mean-variance theory-based portfolio strategies do not consistently outperform the naive 1/N portfolio that invests equally across N risky assets. In this paper, I introduce a portfolio strategy that can consistently outperform the 1/N portfolio. The strategy is investing in a global minimum variance portfolio (GMVP) that is constructed using the diagonal sample covariance matrix of asset returns. Like the 1/N portfolio, also the GMVP constructed using the diagonal covariance matrix has the appealing features of no short sale positions and simple implementation. Thus, from a practical point of view, when evaluating the performance of a particular portfolio strategy, the GMVP constructed using the diagonal matrix should serve at least as a first obvious benchmark.
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